Commodity Index
A Commodity Index is a benchmark that tracks the price performance of a basket of commodity futures contracts, providing a single number that represents the aggregate return from exposure to a diversified set of physical commodities including energy, metals, and agricultural products.
The major commodity indices differ in their composition, weighting methodology, and rebalancing rules, which leads to materially different performance profiles. The Bloomberg Commodity Index (BCOM, formerly the Dow Jones-AIG Commodity Index) and the S&P GSCI (Goldman Sachs Commodity Index) are the two most widely referenced benchmarks. The S&P GSCI is heavily weighted toward energy (particularly crude oil), which tends to make it more volatile and more highly correlated with oil prices. BCOM applies diversification caps that prevent any single commodity or sector from dominating, resulting in a more balanced exposure across energy, metals, and agriculture.
Commodity indices measure the return from holding a rolling series of futures contracts, not from holding physical commodities directly. The total return of a commodity index has three components: the spot return (changes in underlying commodity prices), the roll return (gain or loss from rolling expiring contracts into next-month contracts), and the collateral return (interest earned on the margin deposited as collateral for futures positions). During periods of persistent contango across commodity markets, the roll return component can be significantly negative, causing index returns to substantially lag spot commodity price changes.
Investors gain exposure to commodity indices through exchange-traded products (ETPs), commodity-linked notes, mutual funds, and over-the-counter swap agreements. The choice of index matters considerably: an investor seeking energy-heavy commodity exposure and comfortable with high volatility might prefer GSCI-linked products, while one seeking broader diversification and lower energy concentration might prefer BCOM-linked instruments.
The rationale for including commodity exposure in a diversified portfolio includes inflation hedging (commodity prices tend to rise with inflation, partly because they are inputs into price indices), diversification (historically moderate or low correlation with equities and bonds), and the geopolitical and supply-shock risk premium embedded in commodity prices. Academic research on these properties is mixed, however, and the roll cost drag during extended contango periods has reduced the attractiveness of passive commodity index investing relative to direct commodity equity exposure for some investors.
Major commodity-linked ETFs tracking these indices include the iPath Bloomberg Commodity Index Total Return ETN (DJP) and the iShares S&P GSCI Commodity-Indexed Trust (GSG). Actively managed commodity funds make their own allocation decisions rather than tracking a fixed index.