Inflation is characterized by rising commodity prices. But what commodity index should we use? There are essentially five broad based commodity indices. There is the CRB, Goldman Sachs, Rogers, DJ-AIG, and the UBS Bloomberg CMCI. They all vary in appearance essentially because of their weightings to different commodity groups. But they are all very similar in that they are based on futures prices. While they all compete for the position of the “Dow Industrial” of commodity prices, in reality it is really a case of “seen one and you have seen them all”.
However, there is one index series that is very different than the ones mentioned above. It is the CRB Spot indices. The CRB Spot Indices date back to 1934 right after the great depression. They have been revised numerous times but are still based on spot prices (as opposed to futures prices). They are interesting because they include many commodities that are not included in the futures based indices (more on this later).
More on the CRB Index as we know it today. There are actually two CRB Futures indices. There is the CRB Continuous Commodity Index (CCI), and there is the Reuters/Jefferies CRB Index (RJCRB). The CCI is the “old” CRB (last revision in 1995). It is essentially comprised of 17 commodities all equally weighted with roughly an equal weighting between the different commodity groups (energy has an 18% weighting). The RJCRB is the “new” CRB Index (it came into being in 2006). It is comprised of 19 commodities but their weightings vary. The key difference is that the RJCRB has a 39% weighting to energy (over double that of the CCI). Click here for a more detailed explanation of the differences.
Getting back to the CRB Spot Indices. Here are the components of the Industrials ( metals & textiles) and foodstuffs (livestock & fats). The Composite is taken by adding the industrials (60%) and foodstuffs together(40%) :
As you can see the components are somewhat different than the futures based indices. Note how there is no inclusion of energy related commodities.
OK what is the point of all this? We think that the CRB Spot indices are a better means by which to judge the movement in commodity prices because they are based on spot (here and now) prices not highly volatile prices for future delivery (which are subject to weird things like contango and backwardation). Yes copper futures may well be subject to “funnies” but what the local scrap merchant dealer pays for copper scrap isn’t subject to these “funnies”. Secondly, we think that the CRB Spot Raw Industrials index is the best representation of what is happening in the industrial heartland of the world economy. Think about it, industrial activity isn’t just about copper or aluminum, it is also about leather, cloth, rubber as well. Put another way, advances in copper prices is nothing but random noise unless it is accompanied by advances in the prices of commodities like rubber, zinc, cotton and wool! The behavior of the CRB Spot Industrial Index suggests that there is genuine industrial demand for commodities (not just stockpiling by the Chinese that your average economist would have you believe), and the behavior of the CRB Spot Composite suggests that the advance in commodities is broad based. The only weakness is associated with foodstuffs (namely wheat and corn).
The CRB Spot indices tell us that world growth is happening and inflation is coming. Of course one cannot trade the spot indices (unless you want to take delivery of a pile of scrap steel etc in your back yard). The spot indices are merely indicators for what is happening in the commodity market and by default the global economy. For exposure to the various commodity sectors we use the ETFs DBC (broad), DBE (energy), DBB (base metals), DBA & COW (agricultural/food), and SLV & GLD(precious metals).
Our global wealth builder portfolio (Earnslaw) in which we manage our retirement funds is up 24% since the start of the year. Subscribers are privy to the holdings and weightings of the portfolio and trades prior to us executing them.
