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S&P GSCI - Commodity index developed by Goldman Sachs
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S&P GSCI - Commodity index developed by Goldman Sachs

created Forex Club24 February 2023

The S&P GSCI Index stands for Goldman Sachs Commodity Index. The index was developed in 1991 by one of the departments of an investment bank Goldman Sachs. In 2007, the index changed hands. It was purchased by a subsidiary of S&P Global, which still owns it.

The S&P GSCI index is designed to reflect the behavior of the broad raw materials market. It includes both energy and agricultural raw materials as well as metals. It is therefore not surprising that the aforementioned index is very often a benchmark for funds and ETFs investing in the commodity market. The index is a great benchmark for long-only and futures strategies.

It is worth mentioning that the index was constructed in such a way that it can be "recreated" by the fund or ETF. This allows the investor to purchase investment products that will be exposed to this index. An example is iShares S&P GSCI Commodity-Indexed Trust ETF.

How does the S&P GSCI index work?

S&P GSCI measures changes in the commodities market. This is a model-weighted index “production-weighted”. This is to reflect the importance of given assets in the economy. Of course, in order to maintain liquidity, some contracts that do not meet the relevant criteria are not included in the index.

According to the methodology developed by S&P Global, there is no limit to the number of commodities that can be included in the S&P GSCI index. An index may include a futures contract that is to have physical delivery and cannot be a financial instrument (e.g. stock, currency, interest rate).

The index consists of 24 futures contracts that cover 5 sectors:

  • energy,
  • agriculture,
  • livestock,
  • precious metals,
  • industrial metals.

It is worth remembering that as a result of price changes, the share of individual components in the index is constantly changing. The components of the S&P GSCI are rebalanced every year.

The index includes the following futures contracts:

Energy

Agriculture

Livestock

Precious metals

Industrial metals

S&P GSCI a contagion i backwardation

One of the disadvantages of the index is its automatic rollover without impact analysis contango and backwardation effects on the profitability of the strategy. This is important because derivatives trading is a bit different than spot trading.

The price of a futures contract may be both higher (contango effect) and lower (backwardation) than the price on the spot market. For this reason, blind rollovers to the next contract can be costly if there is a lot of contango.

Contango is dangerous for contract buyers. The higher forward price than the market price is often caused by the costs of insurance and storage of goods. In addition, the reason for the discrepancy between the futures price and the market price is also the opportunity cost and market expectations. This last factor can be very important. A great example was the behavior of WTI oil futures during the COVID-19 period. There was a time when the May delivery futures traded below $20 while the “October” futures traded at $30. So the Contango effect in this case was 50%.

Application of S&P GSCI in investments

The index can be an interesting idea to gain exposure to the commodity market. By purchasing an ETF, an investor can gain exposure to the index at a low cost. Another way is to use futures contracts on the S&P GSCI Index. Futures on the S&P GSCI index have a multiplier of 250. A futures contract on this index is at Chicago Mercantile Exchange (CME). However, it is worth noting that this is not a very liquid index. The volume on this instrument is usually several pieces.

The rates of return also do not encourage direct, long-term investment in the index. At the end of January 2023, the average annual rates of return for individual periods were as follows:

  • 5 years: +5,72%
  • 10 years: -3,72%

While the last 3 years have been a good period for a large group of raw materials. As a result, the average annual rate of return for the last 3 years is: +14,75%. Given the disparity, investing in the S&P GSCI should be short to medium term. However, it is not a "buy and forget" instrument.

Another investment idea is constructing a long-short strategy. It consists in taking a long position in one commodity (or several), which we assume will perform better than the entire index. At the same time, in order to hedge the position, taking a short position on the index (using futures contracts) is used.

Other “raw material” indices

The S&P GSCI is not the only index that measures commodity market performance. Among the most famous are:

  • Credit Suisse Commodity Benchmark Index,
  • Rogers International Commodities Index,
  • Bloomberg Commodity Total Return Index,
  • The Dow Jones Commodity Index (DJCI).

It is worth mentioning that the S&P Dow Jones Indices (owner of the S&P GSCI index) also owns Dow Jones Commodity Index (DJCI).

Summation

The S&P GSCI is a well-known index that measures the performance of a broad basket of commodities. It can therefore be an interesting benchmark for funds that trade on the commodity market. It is possible to use index futures for a long-short strategy. Another idea might be to speculate on futures contracts or trade ETFs giving exposure to this index. However, please note that long-term returns on the index are much lower than for equity indices. This is due to the fact that commodity prices usually move in cycles: from shortage to oversupply.

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Forex Club
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