Intelligent Index Design Delivers in Q4
January 13, 2023
Read Time 4 MIN
Natural Gas Contributes From Rebalance
December was a mixed month for commodity index strategies overall. The UBS Constant Maturity Commodity Index (CMCI) had a good month relative to the industry’s primary benchmark, the Bloomberg Commodity Index (BCOM); 0.3% and -2.4%, respectively. BCOM outperformed for most of the year due to its overweight in natural gas. However, CMCI’s index design paid off at the end of the year. CMCI has a smaller natural gas position by design, but most importantly, the index rebalances monthly back to its target weightings.
Natural gas was the strongest commodity for most index strategies. Not surprisingly, BCOM’s weighting grew during the year to over 13%, which was its largest individual commodity exposure by far. Due to some very unseasonably warm weather forecasts for the U.S. northeast, U.S. natural gas prices fell sharply in December. BCOM’s natural gas exposure declined by 33%, costing the index 4.5% for the month.
Since CMCI rebalances back to its 3.5% target weighting every month, the index’s natural gas position showed losses in December of 24% on the smaller exposure. This cost the index less than 1%. We like to highlight CMCI’s rebalancing feature which has been effective in combatting extreme price movements in individual commodities, which very often means reverting. By rebalancing monthly, CMCI lowers overall volatility and often takes profits on extreme price movements.
Commodity Sector Target Component Weights
Source: Bloomberg. CMCI’s Target Weights as of July 2022; BCOM’s Target Weights as of November 2022.
Index & Sector Review: Energy Led YTD while Precious Metals Rebounded in December
The precious metals sector was the strongest performing sector in December, rising over 5%. This was led by a very strong rally in silver, up 10%. The decline in the U.S. dollar also supported the precious metals rally.
The agriculture, industrial metals and livestock sectors were all modestly higher in December.
The energy sector led all sectors, continuing the trend from 2021. The strongest gains for the energy sector came from gasoil and heating oil. Both gained roughly 40% and almost 70%, including roll yield for the year. This is a supply problem that could persist and might keep heating oil and gasoil prices high and rising for a few years.
The agriculture sector gained approximately 17% for the year. The Russia-Ukraine war disrupted global agricultural trades in the production of corn, wheat, and fertilizer.
The livestock sector gained about 9% for the year. Lean hogs were up 18%, but CMCI’s monthly rebalancing improved returns. The livestock sector has a small weighting in the index so the overall contribution to the index returns was modest.
The precious metals sector was close to unchanged for the year but also had a volatile roller coaster ride. Gold prices rose early in the year from $1,800 to over $2,000 due to fears of Russia’s invasion of Ukraine. Prices peaked shortly after the invasion and declined until early November; bottoming just above $1,600. The U.S. dollar peaked in early September and started to decline in early November, allowing gold to recover losses into year-end, completing the roller coaster ride to finish unchanged at $1,800.
The worst-performing sector for 2022 was the industrial metals sector. This is an important sector for CMCI due to having the highest relative exposure to the sector when compared to other major commodity index products available in the market. Copper, the largest individual commodity exposure in the metals sector, declined by over 10% for the year. This was offset by a very big rally in nickel prices which rose almost 50% in 2022.
Looking Ahead - 2023
Curve positioning, roll methodology and monthly rebalancing all help CMCI outperform BCOM over the long term. In the short term, it can hurt relative performance, as evident in several months in 2022. We anticipate 2023 to be a good year for commodity index products. China’s reopening of its economy from the Zero-COVID policies is expected to cause a burst of economic growth in the Spring. Additionally, the U.S. Federal Reserve’s aggressive tightening is likely to end in the first half of the year. And finally, as the Russia-Ukraine war prolongs, supply constraints are likely to remain consistent, resulting in positive roll yields.
Roll Yield Estimates YTD - December 2022
Source: Bloomberg. Data as of December 31, 2022.
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