Sunday, March 30, 2014

Commodity benchmarks are a problem

The above tables were taken from an article in the Journal of Indexes. It focuses on one of the key problems of commodity investing, determining what is the right commodity index to use for an allocation decision. 

Selecting a commodity index is a problem because the cost of being wrong is significant. There is a wide dispersion in the risk and return with commodity indices that is not seen with fixed income or equities. There is actually a simple reason for the large dispersion. Commodities do not cluster as closely as fixed income or equities. The correlations between sectors are low. Energy is not the same as agriculture or metals. Hence, you cannot view commodity indices as being similar when small changes in weights will have a big impact on returns.

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