Commodities Indexes and ETFs

Commodities have been in a strong bull market since 1999, far outpacing large cap stocks in returns. Most investment professionals expect commodities to continue outperforming stocks as they have done for 9 years, especially now that central banks such as the U.S. Federal Reserve and Bank of Canada are lowering interest rates and further weakening currencies against real benchmarks such as commodities.

It is important to understand index measurements as they relate to commodities, just as for example the S&P 500 is an index reflecting American large cap stocks. The following are the main indexes used in commodity investments, listed in order of our preference:

• CRB/CCI (Continuous Commodity Index), the old Commodity Research Bureau (CRB) index developed in 1957. This is an equally-weighted index of 17 commodity futures and is the most cited historical index. From a technical perspective, this index has consistently reflected the bull market in commodities and is our preferred commodity index for analysis. Every investor should watch the CCI index to monitor the commodity bull market and inflation. See 3-year chart of CCI.

• DJ AIG Commodity Index, a weighted index that is more evenly weighted than GSCI. This index has a substantial agriculture weighting, second only to CCI.

• DBC (Deutsche Bank Commodity Index), a relatively new index launched in 2003. The index tracks six commodities in an uneven weighting, emphasizing energy components (over 50% of the index).

• Reuters/Jefferies CRB Index, the new CRB index launched in 2005. The index is now unevenly weighted and continually readjusted, which we believe makes the index less reliable for long term technical analysis and unsuitable for historical comparison. This new index is heavy in energy commodities.

• GSCI (previously Goldman Sachs Commodity Index), is an unevenly weighted index that is extremely heavy in energy components and very underweight in metals. We believe that the index is too unevenly weighted to be useful, unless you are exclusively investing in energy.

If you have access to futures markets, you can trade futures that track several of these indexes. Unfortunately many small investors do not have access to futures, so the next best alternative are Exchange Traded Funds (ETFs) which trade on stock markets. The following are known commodity index ETFs. Each of these aims to track its related index, though actual index tracking may be imperfect or even fail completely:

• Greenhaven Continuous Commodity Index Fund (GCC) tracks the CRB-CCI (old index), the oldest index, and trades on AMEX. MER is 0.85%
• PowerShares index fund (DBC) track DBC and other DB indexes. Trades on AMEX. MER is 0.83%
• Lyxor commodities ETF (LCTY) tracks the Reuters/Jefferies CRB index (new index) and trades in London. MER is 0.65%
• EasyETF GSCI tracks the GSCI and trades on several European exchanges.
• iPath DJ-AIG (DJP) is an unsecured debt security which tracks the DJ AIG commodity index and trades on AMEX. MER is 0.75%

Warning about credit risk:

• Many commodity ETFs contain, besides futures, substantial corporate paper, money market instruments, or other derivatives. These may involve substantial credit risk. In other words, it's possible to lose money even if the commodities rise in value.
• Some vehicles, for example DJP, are in fact unsecured debt notes which are backed by the issuer. The funds do not contain the commodities, but are rather promises from investment banks to create returns based on an index. These are more like hedge fund investments than ETFs. There is concentrated credit risk, and these should be avoided.
• Always fully research your investment so that you understand what it holds and who backs the instruments. An ideal commodity index investment would purely hold commodity futures which trade through a major clearing house, and store cash in Government-backed securities that involve no counter-party risk.

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