What Is a Commodity Index and Its Functions?

What Is a Commodity Index?

A commodity index tracks the price and returns on a basket of commodities. Investors can access these indexes through mutual funds or exchange-traded funds (ETFs). Many investors choose to invest in commodity index funds to gain exposure to the commodities market without entering the futures market.

The value of these indexes fluctuates based on their underlying commodities and can be traded on an exchange, similar to stock index futures.

Key Takeaways

• A commodity index tracks the price of a basket of commodities.
• The value of these indexes fluctuates based on their underlying commodities.
• Commodity indexes vary in their weighting and composition of commodities.
• The total return of a commodity index depends entirely on the capital gains or price performance of the commodities in the index.

Understanding a Commodity Index

Every commodity index has a different makeup in terms of the commodities it includes. For example, the Refinitiv/CoreCommodity CRB Total Return Index consists of 19 different types of commodities, such as cocoa, soybeans, gold, crude oil, and wheat.

Commodity indexes also have different weightings. Some indexes use equal weighting, where each commodity has the same percentage of the index. Others have predetermined weightings that may prioritize specific commodities, such as energy-related commodities like coal and oil over agricultural commodities.

Investors cannot directly invest in a commodity index, but they can invest in funds that track specific indexes. Investing in commodity index funds became popular in the early 2000s due to rising oil prices and increased Chinese industrial production.

China’s growing economy and limited global supply of commodities drove up commodity prices, leading many investors to seek investment opportunities in raw materials for industrial production.

Special Considerations

Commodity indexes differ from other indexes in one important way—their total return depends solely on the capital gains or price performance of the commodities in the index.

Unlike most investments that include cash receipts like interest and dividends in the total return, commodities do not pay dividends or interest. As a result, an investor’s return depends exclusively on capital gains. If commodity prices do not rise, the investor experiences no return on their investment.

In contrast, bonds that pay interest and stocks that pay dividends always provide a positive return. For example, even if a stock price remains unchanged, a dividend payment still yields a positive return on investment.

Major Examples of Commodity Indexes

The major commodity indexes include the S&P GSCI Index, the Bloomberg Commodity Index, and the DBIQ Optimum Yield Diversified Commodity Index. These are just a few examples of the many commodity indexes available to investors.

How Can I Buy Commodities?

Investors have three primary methods to buy commodities. They can purchase the commodity outright, invest in stocks of commodity-related companies like oil and gas companies, or invest in funds with commodity exposure. The simplest method is to invest in an exchange-traded fund (ETF) that provides commodity exposure.

What Composes a Commodity Index?

A commodity index consists of underlying commodities such as wheat, oil, gold, or soybeans. The index tracks a basket of commodities, and its performance depends on the price movements of these underlying commodities.

A commodity index consists of underlying commodities such as wheat, oil, gold, or soybeans. The index tracks a basket of commodities, and its performance depends on the price movements of these underlying commodities.