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Last week, the S&P Goldman Sachs Commodity Index (GSCI) closed up 21 percent from its June low. Since a 20 percent move is the accepted milestone for measuring bull and bear markets … this puts the popular index of raw materials in fresh bull market territory.
Commodity bulls rejoice!
After all, the recent gains follow a brutal bear market decline of 21.9 percent from March through June. And it’s been a broad based move for materials led mainly by agricultural commodities and energy. But even long dormant precious metals have finally perked up with gold and silver both joining the upside move last week.
The well publicized drought in the U.S. has been largely responsible for the recent surge in grain prices. Soybeans rose to a record last week, up over 40 percent so far this year. Wheat and corn are not far behind posting 2012 gains of 41 and 30 percent respectively.
Corn prices have popped 66 percent higher just since mid-June amid reduced crop forecasts due to parched farmland across the Midwest.
Energy has also been a key driver of commodity prices. Crude oil and gasoline prices have been moving steadily higher elevated as market conditions remain tight in spite of reduced global demand expectations.
Add in a risk premium for escalating tensions in the Middle East, plus a string of storms taking aim at offshore drilling rigs in the Gulf of Mexico, and crude oil futures have jumped 8 percent in the past month alone.
Of course there are many other commodity indexes that can tell a very different tale depending on which commodities are performing best.
So before you invest, it’s important to understand the …
Big Differences in
Commodity ETF Construction
S&P’s GSCI for example is substantially overweight energy related commodities, which make up 70.5 percent of the entire index. Considering crude oil has bubbled up almost 25 percent since the end of June it has really fueled the recent run in GSCI.
Agriculture by contrast, accounts for only 17 percent of the GSCI, so surging grain prices have had a lesser impact on the index. And precious metals with a 3.5 percent index weight exert even less influence on this index.
My personal favorite for tracking commodities — the CRB Continuous Commodity Index (CCI) — has a very different and more broad-based construction. CCI includes 17 commodities that are more equitably distributed in the index with none too dominant.
Energy, for example, accounts for only 17.6 percent of the CCI, while agriculture products and metals both carry greater weight. Alas, the broad based CCI has yet to enter a new bull market.
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| The percentage of energy stocks a commodity ETF holds depends on which index it follows. |
Although it’s up a respectable 12.3 percent since the June low, it is still playing catch up to the energy-dominant GSCI.
This distinction between commodity indexes and how they’re constructed is an important reminder for investors to always read the fine print in every ETF prospectus … so you know exactly what you own.
After all, today you often face multiple choices when it comes to ETFs that appear to track the same underlying asset class or index, but are often put together very differently.
ETFs, like the indexes they follow, are not created equal.
So, if you believe energy outperformance is likely to continue, then you may want to take a closer look at the iShares S&P GSCI Commodity Index ETF (GSG) with its energy sector dominance.
On the other hand, if you’re looking for more broad based exposure to all commodities, the GreenHaven Continuous Commodity Index ETF (GCC), which tracks the CCI, may be worthy of further research on your part.
Is It Time for Gold
to Glitter Again?
Another very popular commodity has contributed the least to recent commodity strength, but may in fact have the most upside potential from here: Gold.
Since hitting a low of $1,526 per ounce in May 2012, gold has gained just 9.3 percent, trailing many other commodities. In fact, the yellow metal has been in a downtrend since September 2011, making a series of lower highs. But recent price action suggests gold prices may finally be perking up, for three important reasons …
#1 Uncertainty: September holds a number of key events that have global investors on edge.
Both the European Central Bank (ECB) and the U.S. Federal Reserve have policy meetings coming up soon, and there’s growing anxiety about the outcome.
The ECB has pledged to reveal details of a plan to put an end to Europe’s debt crisis, perhaps through a program of government bond purchases targeting Spain, Italy and other troubled nations.
Expectations are also running high that the Fed may launch more quantitative easing, in an attempt to lift the sagging U.S. economy and jump-start job growth.
Both of these measures mean more money-printing — plain and simple — which is very good for gold.
#2 Demand: Gold seems to be in high demand once again. Billionaire hedge fund managers John Paulson and George Soros both increased their stake in the yellow metal, by recently adding to their holdings in the SPDR Gold Trust ETF (GLD).
Bloomberg recently reported that total exchange traded holdings of gold rose by 90.4 tons so far this year, to a record 2,447.1 tons! So Paulson and Soros are finding plenty of company investing in GLD and other gold-based ETFs.
And global central banks have also been on a gold buying spree lately, with bullion purchases setting a three-year high last quarter. Central banks are clearly looking to diversify their foreign exchange holdings away from the U.S. dollar — and especially the euro — given the prospect for more money-printing.
After all, in a world of depreciating paper money, gold is the ultimate sound currency.
#3 Seasonality: Best of all, and as you can see in the chart above, gold has definite seasonal tendencies. And we’re just now approaching the time of year when gold prices really shine!
September and November are the best two months of the year for gold prices in terms of average upside potential. And over the entire period from August through February, gold prices have historically gained 21.5 percent on average — that’s what I call a seasonal sweet spot!
Gold is just beginning to perk up after a long correction. And considering the volatility we’ve witnessed in markets all year, along with the uncertainties that still lie ahead, you may want to look into adding gold to your portfolio too.
Good investing,
Mike Burnick
P.S. Last week I recommended a gold ETF for my International ETF Trader members. But commodities aren’t the only ETFs I follow. I watch ETFs that invest in all parts of the world, including Africa, Latin America, and Asia. To learn how you can profit from ever-changing global market conditions by identifying which ETFs have the most profit potential at any given time, click here.
Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.