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The Reweighting of Commodity Indices

Posted: Jan 03 2011     By: Dan Norcini      Post Edited: January 3, 2011 at 9:27 pm
Filed under: Trader Dan Norcini

Dear Friends,
Every year around this time some of the big commodity indices that are used as benchmarks by various fund managers are reweighted with the percentage of the commodities making up the basket tracked by each particular index varying depending on the methodology employed by the owners of the index.
Two of the larger commodity indexes are the Goldman Sachs Commodity Index (now called the S&P GSCI) and the Dow Jones – AIG Commodity Index).
My preliminary read of the GSCI index shows a heavier weighting in both silver and copper over the weighting given to each last year (2010) and a bit of a lighter weighting given to gold than last year.
Copper and silver are both being increased  2.7% over last year while gold is being reduced 2.5% compared to last year. Disclaimer – I hate reading through these reports issued about the various indices as my head goes numb from looking at the all the calculations so these numbers should not be taken as gospel until I can confirm the exact change. For now – this is my preliminary read.
Generally what this translates to in terms of the average market watcher is that the commodity style funds that commit investment funds into the commodity complex, must match the percentage of their holdings to these various indices. Depending on which index they choose to benchmark against and what changes may or may not be made for the new calendar year, such changes may result in an increase in buying for some commodities and an increase in selling for others. The reason is that the fund managers must rebalance their holdings to bring them into line with the new weightings in the index.
Since the largest portion of the money driving our commodity markets these days is the result of these commodity funds, the changes can sometimes explain some of the price action that the various commodity markets will experience during the rebalancing phase. This phase tends to last a few weeks as the index re-weightings become published and disseminated through the investment community and are then implemented by fund managers.
Keep this in mind as we watch the price action over this month.
Also keep in mind that any fresh money coming into the markets for investment for the new year is going to find itself being spread across all of the various commodities making up each commodity index. Sometimes that new money is more than enough to offset the selling of the older positions from the previous year as the fund managers rebalance. For those markets where the percentage weighting has been increased from the previous year, the combination of fresh, new investment money for the new year in combination with the increased need by the funds to buy extra positions in those commodities, can be quite a powerful combination for any market already in a bullish uptrend.
I have yet to examine the DOW JONES AIG index. When I do, I will report back to our readers.