Two Questions--Commodity Index Fund--how much / what index

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Rick Ferri
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Post by Rick Ferri »

Larry,

Your belief that all arbitrage must be risk free does not follow when dozens of hedge funds that were doing arbitrage lost hugely over the past 18 months with many going. For example, statistical arbitrage depends heavily on the ability of market prices to return to a historical or predicted normal. When it doesn't, the arbitragers lose (this is what brought down LTC in 1998 and many other hedge funds recently). In merger arbitrage, profits depend on a merger actually going through. In interest rate arbitrage, an investor borrows money to buy a currency with a higher interest rate in order to capture the difference between the two interest rates. As long as there is regression to the mean, then the trade was a success. But this strategy can loss money if the spread widens.

A person may not believe that statistical arbitrage, merger arbitrage, and interest rate arbitrage are actually arbitrage because the trades are not risk free. But I do not think he will find many people in the industry who would follow that definition.

This is just a conversation. I don't think anyone on this board is actually doing arbitrage, but it is a good idea to agree on the definition.

Rick Ferri
bdavidson
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As an uninterested, uninformed observer to this banter...

Post by bdavidson »

I could not care less about the actual topic being discussed here, since it's beyond my current investing prowess, but after waiting with baited breath for each volley between the main participants, I just had to thank you both for the comic relief of this exhibition.

IMO, Larry is doing a slight disservice to himself by repeatedly harping on Rick for allegedly being wrong based on "facts" that aren't always directly referenced. (This is just my opinion based on what I remember from reading -- I've done no fact-checking of my own.)

Rick wins in terms of proper grammar and punctuation. He probably has really nice penmanship too. :D Larry seems to hate the apostrophe on his keyboard, but love the jargon that's above my head (e.g. "arbing" on the run vs the off the run).

Overall, I call it a draw. As reward (or punishment) for you both, I will not be buying either of your books on Amazon. Instead, I will borrow them from a local library. :lol:

If the OP feels his question has been answered, maybe we should all just move along and enjoy the long U.S. holiday weekend.

Happy Independence Day to you both, and to all Bogleheads!
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Robert T
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Post by Robert T »

.
More on ‘event risk’ hedge

Here’s a look at oil price changes, and US stocks and bond returns using the episodes/event identified in the linked article Oil and the Macroeconomy since World War II. Results are presented in table below.

Few observations:
  • - Average oil price changes across all episodes/events listed below was large relative to average returns on stocks and bonds.
    - The difference in oil price changes across episodes/events was dramatic, from 6.4% to 213.5% (often seems to be a convergence of factors that lead to dramatic price spikes). "Outliers" seems to drive the mean....
    - The 1973-74 oil price changes was significantly larger than the GSCI return (which in 1973-74 only included cattle, corn, soyabeans, and wheat).
Another article in 1985 by the same author of the above linked paper concluded: “The political history of the Middle East makes it almost inevitable that sometime in within the next decade economists will be granted some more data with which to assess the economic effects of supply disruptions”. Now there may never be another oil supply disruption again, or if there is it will have a small effect, or it could be very signficant - similar to 1973-74. No one knows. We each has to weigth the risk. As indicated before, of all the reasons for CCF inclusion – the non-financial event risk hedge is the strongest IMO. This is just an attempt at an example.

Code: Select all

                                                       % change
-----------------------------------------------------------------------
            Episode/event                       5yr        US      Oil
                                              T-Note    Stocks   Price*

1947-48     Post WWII                            2.8      5.8     58.6
1952-53     Iranian Nationalization              4.9     14.2      9.7
1956-57	  Suez crisis                          7.4     -2.5      6.4
1969        Decline in US reserves              -0.7    -10.9      9.1  
1970        Rupture of trans-Arabian pipeline   16.8      0.0      6.3	
1973-74     OPEC embargo                        10.6    -40.4    213.5   
1978-79     Iranian revolution                   7.7     32.2    118.9    
1980-81     Iran-Iraq war                       13.7     27.8      7.7	
1990        Persian gulf war                     9.7     -6.0     29.6
----------------------------------------------------------------------
Average                                          8.1      2.2     51.1

* Spot Oil Price: West Texas Intermediate

Robert
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WileECoyote
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Post by WileECoyote »

Robert T - great info! Where did you get the info for the % change for oil prices? I've been looking for that same data.

This goes with what I mentioned on page 2, I wonder if it's more the strength of oil within the commodities indexes vs the rest that drives returns during tumultuous times. I doubt it's investor's sudden fear about soybean supplies during a market disruption that drives up commodity returns. But oil, that's another story.

Then possibly the rebalancing function of the index helps to drive returns during relatively calm periods?
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Robert T
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Post by Robert T »

WileECoyote wrote:Where did you get the info for the % change for oil prices?
http://research.stlouisfed.org/fred2/data/OILPRICE.txt
WileECoyote wrote:I doubt it's investor's sudden fear about soybean supplies during a market disruption that drives up commodity returns.
An el nino induced widespread drought in 1972 seems to have affected global food production leading to the spike in grain prices (re: the GSCI in 1973-74). So supply disruptions can affect agriculture commodity returns, but in both the current GSCI and DJ AIG commodity index energy dominates the weighting. And a convergence of factors (eg. drought, oil embargo, conflict, etc as in 1973-74) seems to amplify the price effects.

Robert
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WileECoyote
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Post by WileECoyote »

Good point, thanks for the link!
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Post by larryswedroe »

Your belief that all arbitrage must be risk free does not follow when dozens of hedge funds that were doing arbitrage lost hugely over the past 18 months with many going
.

The problem is simply the use of the term arbitrage--if there is price risk it is speculation and not arbitrage. This is simple ENGLISH--but I guess not so simple.

Those hedge funds cited like LTCM were not engaged in arbitrage. Betting there will be convergence between the price of a 29 year bond and a 30 year bond is not arbitrage, it is speculation.

Now some have distorted the term and misuse it. Just like the term hedge fund is an incorrect term for almost all that employ it. They don't hedge anything--at least most don't. They speculate. Again, hedge means to reduce risk. The same is true about the use of the term arbitrage by the industry. Just because they misuse the term doesn't make it correct any more than millions of people saying the earth is flat doesn't make it correct or any less foolish
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Post by larryswedroe »

bdavidson

I point out when ever I see anyone make a mistake that people should be aware of is an incorrect statement. I do it all the time with what is written in the press for example, or here as well. Sometimes things are opinions--then I state IMO or I disagree. But if something is factually wrong it is just wrong. And people need the correct information to make an informed decision.

But enough for me on this particular issue.
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Cb
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Re: Two Questions--Commodity Index Fund--how much / what ind

Post by Cb »

Les wrote: Regarding question 2 in the OP, what Yahoo quote is the best for just watching the commodity indexes?

Is it iPath S&P GSCI Total Return Index ETN (GSP)? I used to watch ^DJC but apparently that has been changed or just been obsoleted. GSP has only about 3 years of chart history on Yahoo.
The DJ-AIG has been renamed DJ-UBS. The Yahoo symbol was ^DJC, which ended June 18. The new symbol is ^DJUBS.

Hopefully Yahoo Finance will append the ^DJC historical data set to the ^DJUBS set before too long.
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BlueEars
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Post by BlueEars »

Cb, thanks! I never would have found that on my own -- that is what I like about this forum. I do hope the ^DJC data gets appended because right now all I can seem to see is the last 5 days of ^DJUBS. I imagine Dow Jones did not want to be associated with the AIG name any more -- or is there another explanation?

In the absence of ^DJC I was using GSP. I now notice that DJP is very similiar to ^DJUBS for the last 5 days trading. DJP is iPath Dow Jones-AIG Commodity Idx TR ETN which is still trading. When I plot DJP versus GSP it looks similiar but with GSP just amplifying the highs and lows.

For GSP the profile is
The investment is linked to the GSCI Total Return Index and provides you with exposure to the returns potentially available through an unleveraged investment in the contracts comprising the GSCI plus the Treasury Bill rate of interest that could be earned on funds committed to the trading of the underlying contracts. The commodities represented in the GSCI Total Return Index are production-weighted to reflect their relative significance to the world economy. Crude oil is currently the dominant commodity in this index. The fund is nondiversified.
For DJP the profile is
The investment seeks to link to the Dow Jones-AIG Commodity Total Return index and reflects the returns that are potentially available through an unleveraged investment in the futures contracts on physical commodities comprising the index plus the rate of interest that could be earned on cash collateral invested in specified Treasury Bills. The commodities represented in the Dow Jones-AIG Commodity index Total Return are rebalanced annually. Each subgroup exposure is capped at 33% as of the January 2006 rebalancing, however the weightings fluctuate between rebalancings due to changes in market prices. The fund is nondiversified.
When I looked at a chart of PCRIX, GSP, DJP it showed PCRIX following DJP from Oct 2006 up to about October 2008 and then PCRIX went down a lot faster then both GSP and DJP. So which is the best way to "watch" commodities in the opinion of those who follow this stuff? Which is the best way to think of an investment in commodities?
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Cb
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Post by Cb »

Les wrote:When I looked at a chart of PCRIX, GSP, DJP it showed PCRIX following DJP from Oct 2006 up to about October 2008 and then PCRIX went down a lot faster then both GSP and DJP. So which is the best way to "watch" commodities in the opinion of those who follow this stuff? Which is the best way to think of an investment in commodities?
I wondered the same thing a year or so ago, so I waited for a recemnt distribution to "settle" in the Yahoo Finance historical data set for PCRIX since inception, then I fetched weekly ^DJC for the same time period, and for a TIPS ETF.

Alongside each column I performed a calculation for the % change from week-to-week. I found that if I summed the returns for ^DJC + the TIPS ETF it showed an extremely high correlation to PCRIX over the entire period.

In fact, I was surprised that PCRIX's rather stiff ER didn't show up in full. I suspect that's because PIMCO's execution was either very good, or they were simply lucky At any rate, PCRIX was not the sum of the Commodity Index plus the TIPS ETF minus the full 0.74%

Last year I would have expected PCRIX to perform worse than the ^DJC because TIPS also fell.

Cb
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BlueEars
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Post by BlueEars »

Cb wrote:...
Last year I would have expected PCRIX to perform worse than the ^DJC because TIPS also fell. ...
Interesting observation. I now realize that I should not have been comparing the Yahoo chart patterns for PCRIX and the ETF's because they do not take distributions into account for charts (they do offer the adjusted price data in the historical data series though).

Morningstar shows that for 3 year CAGR:

Code: Select all

PCRIX  -8.16%
DJP    -9.79%
GSP    -17.07%
So I'm still wondering if GSP is the best to watch in relation to commodities? As mentioned above GSP has commodities "production-weighted to reflect their relative significance to the world economy. Crude oil is currently the dominant commodity in this index."
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Post by stratton »

Les wrote:Morningstar shows that for 3 year CAGR:

Code: Select all

PCRIX  -8.16%
DJP    -9.79%
GSP    -17.07%
So I'm still wondering if GSP is the best to watch in relation to commodities? As mentioned above GSP has commodities "production-weighted to reflect their relative significance to the world economy. Crude oil is currently the dominant commodity in this index."
You can sure see the 70% in energy in GSP from those numbers.

Paul
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Rick Ferri
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Post by Rick Ferri »

Les wrote:Morningstar shows that for 3 year CAGR:

Code: Select all

PCRIX  -8.16%
DJP    -9.79%
GSP    -17.07%
So I'm still wondering if GSP is the best to watch in relation to commodities? As mentioned above GSP has commodities "production-weighted to reflect their relative significance to the world economy. Crude oil is currently the dominant commodity in this index."
PCRIX is is not a commodities index. It is a mutual fund that has a an dual investment strategy of long DJ-UBS forward contracts, short T-bills / long TIPS. The performance is rather irrelevent unless you are invested in the fund.

DJP follow the DJ-UBS (formally AIG). That is a quasi-actively managed index that uses fixed sector caps and rebalancing as part of the strategy. It does only a mediocre job of telling you what the commodities market is doing.

GSP is the S&P GSCI - this is the only benchmark of global commodities values. If you want to know what the representative dollar value of the commodities market is in aggregate, then GSP is the best one to watch.

Rick Ferri
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Post by larryswedroe »

RE PIMCO, they don't purely index--they act more like DFA in terms of trading. They don't roll the contracts as the index does as that leads to active investors being able to exploit indexers as they do with the R2k.

That is why IMO it makes no difference whether a fund is an index, but only what is the best investment strategy. Since they took control over the rolls they have added value.

Now they also make bets on the collateral (I wish they did not) so that they not only seem to manage TIPS like I do (shifting maturities) but they also make lots of small bets on the other collateral (about 10%)--so they also buy EM bonds and Euro IPS, etc. That of course leads to tracking error. While I would prefer an all TIPS approach, you could do lot worse than have Gross managing your fixed income investments---and it is only small percent of the collateral _--no more than 10%.
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Post by BFskinnerpunk »

Good grief... I'm having trouble following this thread (but I want to!).

So, um, is GSP the way to go if you want exposure to commodities?

I've got a little doom and gloom Peter Schiff type notions in me, so be nice.

The bulk of my investments are going to be boring total market type indexes, but I'm interested in humoring my exotic, paranoid right-winger style fear investing as well.

I'd like to be able to do it all through my Vanguard account, too. I suppose I'll need to open a Vanguard *brokerage* account.

BF
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Robert T
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Post by Robert T »

Rick Ferri wrote:GSP is the S&P GSCI - this is the only benchmark of global commodities values.
The index is production weighted (as I understand) - so seems to differ from a cap weighted benchmark (re: commodities values). Robert
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Post by BlueEars »

Rick Ferri wrote:...(snip)...
DJP follow the DJ-UBS (formally AIG). That is a quasi-actively managed index that uses fixed sector caps and rebalancing as part of the strategy. It does only a mediocre job of telling you what the commodities market is doing.

GSP is the S&P GSCI - this is the only benchmark of global commodities values. If you want to know what the representative dollar value of the commodities market is in aggregate, then GSP is the best one to watch.
Rick and Robert, thanks. I think probably GSP is what I'm most interested in for following commodities and their effects on stock & bond investments, geopolitics, etc. The links Robert provided are very useful.

One of Robert's links led me to the S&P GSCI fact sheet: http://www2.standardandpoors.com/spf/pd ... tsheet.pdf
This gives the dollar weighting of the various components on page 2. For instance, Energy (crude oil, brent crude,natural gas, etc) is 65% and Agriculture (wheat, sugar, etc) is 19%.
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Rick Ferri
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Post by Rick Ferri »

Robert T wrote:
Rick Ferri wrote:GSP is the S&P GSCI - this is the only benchmark of global commodities values.
The index is production weighted (as I understand) - so seems to differ from a cap weighted benchmark (re: commodities values).
Five-year average production weight is the best measure of relative commodity market values since it is not possible to know the amount of commodities on the market at any time. The idea is to give weight in the index to each commodity based on economic significance. The S&P GSCI is the only index that attempts to do that. It is not perfect, but it is better than the other indexes. Those others where designed as portfolio management strategies for investing in commodity futures rather than as commodity futures benchmarks.

Rick Ferri
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