Commodity futures programs are continuing to attract significant capital from investors. According to Goldman Sachs, an estimated $12 billion is invested in or benchmarked to the Goldman Sachs Commodity Index (GSCI).
The GSCI, designed to be a benchmark for commodity investors comparable to the S&P 500 Index for equities, is a world-production-weighted commodity index, incorporating futures contracts that span five commodity sectors (see "Pieces of the pie," right). Like the S&P 500 Index, a GSCI futures contract trades on the Chicago Mercantile Exchange. With only one futures contract investors are able to gain exposure to a basket of diversified, commodity futures contracts.
HITTING THE CURVES
A previous article ("Trading Scarcity," October 2000) argued that you should consider using a reliable indicator of scarcity to decide whether to invest in the GSCI. That indicator is the "term structure" of the GSCI futures curve.
Term structure means you should examine the relative price differences of GSCI contracts across delivery months. When a near-month contract is trading at a premium to more distant contracts, a commodity futures curve is said to be "in backwardation." Correspondingly, when a near-month contract is trading at a discount to more distant contracts, the curve is "in contango."
When the GSCI is trading in backwardation, you should consider investing in the GSCI: Scarcity is indicated when investors are willing to pay a premium for immediately deliverable commodity futures contracts. When the GSCI is trading in contango, you should consider reducing your investment in commodities: Scarcity is not indicated.
Using this key market relationship, the premise is that you might be able to improve the timing of long-term positions in the futures markets.
"Timing pays off" (right). reviews the results of investing in the GSCI from mid-1992 through June 2000 using three different policies:
1. Invest in the GSCI throughout the entire period.
2. Invest only when the GSCI curve is in backwardation.
3. Invest only when the GSCI curve is in contango.
At the end of the investment horizon, the passive investment made 3.8%, while the backwardation investment conditional gained 39.1%, and the contango investment conditional lost 25.3%, as reported in the previous article. (These results exclude the returns from interest income on collateral.)
This strongly suggests that the GSCI's curve shape is a useful timing indicator.
But how has this indicator performed since the original study in the summer of 2000? Rather well, it turns out (see "Updating the value of timing" right). From the summer of 2000 through March 2003, the passive investment made 3.7%, while the backwardation investment conditional gained 8.1%, and the contango investment conditional lost 4.1%.
The usefulness of examining the curve shape for an investment in the GSCI appears to be confirmed.
For a …