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Saturday, January 25, 2014

Real Stuff

As I was reflecting on 'how things don't fit together anymore' in The Big Dogs and HorseShit post (link) back in early December 2013, I was keep going back to situation with commodities. S&P has gone back down to levels of two months ago, but all it did was to relieve some overbought conditions. As nasty as last Friday candle looks, it brought NYAD indicator into (at-least) bounce territory. We have been down this road so many times in 2013, its kinda comical to watch it again. I am withholding judgement on index direction and levels for now. System 9 allocation is a bit over 50%, mostly long with SRS and 1/2TBT.

 For a variety of reasons, my mind keeps drifting back to commodities -  real, heavy... you know...stuff. Some of them are more important than others, driven by different fundamentals, politics, investment fads etc. There are so many opinions and various research out there, plus my own views - makes trading decisions a very conflicting process. As usual, when I smell investment opportunity, I trust my gut, but go by charts. Price plot contains all the information I need. Commodity Index turned out to be a complicated problem.

The definitive paper on subject of Commodities Indexing seems to be " Facts and Fantasies about Commodity Futures" by Wharton and Yale professors.
I haven't read whole thing yet, but here is from their Summary:
We construct an equally-weighted index of commodity futures... The correlation with stocks and bonds is negative over most horizons, and the negative correlation is stronger over longer holding periods... commodity futures perform better in periods of unexpected inflation, when stock and bond returns generally disappoint.
 'All Down' bear market had been something I was pondering about for years. Stocks, bonds and commodities all down together, with no place to hide, would be a truly catastrophic financial condition. Still only a theoretical possibility, especially with commodities down so much already... Sure, corn and cotton can fall, but they are not going to zero. Can't say the same about FB and TWTR.

 "Unexpected inflation" my ass. Inflation has been here, much higher that reported numbers, and very very real. Not if, but when it will become 'official' - that will be a truly 'unexpected', Black Swan type of event - inevitably leading to rapid repricing of all Real Stuff. Timing is uncertain, so I'm taking it one step at the time, in order to not get killed (financially) between now and then.

 There is also a matter of Commodity SuperCycle and Kondratiev Cycle, but I don't want to get into it now.

Thomson Reuters/Jefferies CRB Index is the oldest, but it undergone so many revisions over the years, I don't know if long term chart should even be considered.
Present composition is 19 commodities, minimum of two delivery months, 5-6 months out. Abnormally large allocation to Crude Oil at 23%, while Silver and Wheat are only 1%.
Energy: 39%
Agriculture: 41%
Precious Metals: 7%
Base/Industrial Metals: 13%

 Thomson Reuters Equal Weight Continuous Commodity Index (CCI) is calculated the same way CRB was done prior to 1995. Equal weight of 17  components, 2 to 5 delivery months, up to 6 months out, arithmetically averaged to 5.88% each. Notable that CCI doesn't have Aluminum, Nickel and Gasoline, but has Platinum and Soy Oil.
There is an GreenHaven Continuous Commodity Index Fund (GCC) etf that closely tracks CCI and rebalanced daily. Exp ratio is close to 1%!
Energy - 18%
Agriculture - 34%
Softs - 24%
Metals - 24%

  Then there is a Goldman Sachs Commodity Index (S&P GSCI), created by evil's at GS right on time for 2007-2008 world food price crisis. Then they sold it to S&P (McGraw Hill), who have zilch info on their site. All I know is there are 24 components, weighted according to world production. Its like market-cap weight, but based on some arbitrary opinion (I guess).

$GNX index seems closely tracked by GSG  iShares etf-Trust with 0.75% exp ratio. All they do is buy 100% futures contracts for S&P GSCI Excess Return Index and hold 0% Treasury Bills as collateral.

The same miscreants from McGraw Hill own Dow-Jones UBS commodity index, but thru different web-site and also will very little info. There seems to be 22 components, with limits of no less than 2% and no more than 15% allocation to each futures, and no sector can represent more than 33%.
DJP is etf for that from iPath with 0.75% fee. I only found 10 holdings in their fact sheet, largest are Nat Gas (12%) and Crude Oil (10%). Complete fucking scam. May be I should invest into MHFI?

Interesting approach of Deutsche Bank Liquid Commodity Index (DBLCI) used by PowerShares DBC. They take 14 most heavily traded contracts in the World, set base weight in November of each year, and just let it roll until next re-balancing. DBC is the biggest and most active commodity index etf.

 And then there is Jim Rogers, Mr Bow-Tie himself, with RJI - Rogers International Commodities Index etf, with traditional 0.75% exp ratio. This monstrosity is based on 37 commodities, heavily weighted in Oil, but seems the most complete and sensible allocation to all the Real Stuff. 

RJI is rebalanced at the start of every month back to initial weights, that changed very little in almost 20 years of index history.


 Charts offer a couple of shocking revelations:
First of all - it doesn't even matter which methodology used, all these charts are fairly similar looking.
Secondly, Over the period since 2008, during bull and bear market, two indexes clearly outperform - equal weighted CCI and market weighted GSCI, and none of etf's even come close to matching performance of indexes.
And finally, and it depends on a period selected for relative performance analysis, but some of worst performers are GSG and DJP - both based on indexes published by McGraw Hill. Meanwhile stock of thy lowly publisher MHFI is up over 300% since 2009 low.

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