Diversified Index Futures Track Our Costs of Consumption
As the U.S. Federal Reserve and the European Central Bank revealed their observations on inflation and interest rates this week, the search for inflation has been a recurring theme. With unemployment near 50-year lows our Fed would like to see inflation of at least 2% as measured by the ex-food and energy consumer price index.
While central banks may not be overly concerned, they hope to avoid a low growth, low inflation, low rate stalemate that has gripped some economies for extended periods.
It’s very possible that inflation could pick up slightly in 2020, and economists envision the Fed’s key measure to approach the 2% target. When Bloomberg asked economists for inflation forecasts, predictions averaged 2.1% year-over-year CPI for 2020, and 2.0% for 2021.
Oil’s importance earns it a look to the future also. Similar polling of commodity analysts produced average estimates for WTI oil prices to drop slightly in each of the next three years, from $56.48 in 2020 down to 51.48 by the end of 2022.
Commodity Performance in 2019
Taking a look at the few isolated performers for this year, natural gas pulled back 20% to normal levels after a volatile November-December period in 2018 took many investors by surprise. The natural gas futures market spiked last fall when a cold snap combined with record low inventories to create abnormally high prices.
Oil rallied with WTI crude oil up 30% YTD as OPEC pledged production reductions and investors re-engaged risky assets after fleeing them late in 2018.
Agricultural products have performed poorly this year, facing challenges of over-supply and/or trade tariff issues. Coffee has been an exception to the ag pullback, enjoying a 33% rally so far this year.
Commodity Exposure and Portfolio Management
Over the years different portfolio management theories have come and gone that address the role commodity exposure should play as a non-correlated asset.
An indexed, or passive approach to adding commodity price exposure can produce positive investment returns in periods of inflation. Studies have argued that passive commodity index exposure adds benefits of portfolio diversification via negative correlation with other asset classes, such as equities and bonds. However disadvantages may arise over time from the condition known as negative roll yield, which can erode returns from certain commodities in the basket. There have also been breakdowns in this negative correlation, notably during the financial crisis ten years ago.
Commodity indexes over the last decade have produced exactly what would be expected during low inflation spans – low returns.
Commodity index returns over the past five years have produced annualized losses of about 6%. Over the same period, the S&P 500 has averaged 11% annual returns, maintaining the spotlight and keeping equity investors relatively happy. Only time will tell what commodity prices have in store for us in the future.
Commodity indexes pool a diverse basket of commodity futures prices, each of which is weighted based on our production or consumption habits. Sine we produce and consume a lot of energy commodities, it makes sense that energy is typically a very heavy portion of many commodity indexes.
Schwab offers access to trade two commodity index futures contracts: the Bloomberg Commodity Index Futures, and the S&P GSCI Futures. With more subdued volume and liquidity in these contracts, Schwab typically offers several front month contracts for trading. Currently we have the December 2019 & March 2020 Bloomberg Commodity Index Futures and the December 2019 & January 2020 S&P GSCI Futures contracts listed.
The Bloomberg Commodity Index (weightings below) reflects the commodity futures price movements of 23 components. The index rebalances the weightings annually based on the component’s contract volume and also by world production of the specific commodities. To maintain appropriate diversity, there are also caps on the weightings at the commodity, sector, and group level.
Technicals Bloomberg Commodity Index Futures
Resistance 2 78.8
Resistance 1 78.6
Support 1 78.2
Support 2 78.0
20-day SMA 78.3
50-day SMA 78.7
200-day SMA 79.2
10-day RSI 52%
Retail Sales 12/13/2019 8:30 a.m. ET
Last Trade Dec. GSCI Futures 12/16/2019
Housing Starts 12/17/2019 8:30 a.m. ET
Last Trade Dec. BBCI Futures 12/18/2019