Here Comes the Commodity Index Rebalancing

The major commodities indices are being rebalanced, and I am forced once again to question their timing.

Recall the last major rebalance: At the time, I had been challenged by Larry Kudlow to find a smoking gun for the sudden 2006 collapse of Oil prices a month or two before the mid-term election.

That challenge led us to discover the actual mechanism — the GSCI rebalancing. Just 3 months prior to the election, GS decided to significantly lower the weight of Oil and Natural Gas, effective a month prior to the election. Prices plummeted, albeit temporarily.

There was a cost to this: Subsequent performance of the index, reweighted with less energy, was negatively impacted, as energy prices for the following 2 years boomed, until Oil peaked at $147. The reweighted indices performed much wore than they would have had they not been changed in ’06.

Bill King noted yesterday:

The weightings for both indices are released ahead of time, but begin to kick in the first few working days of the new year. In the case of the DJ-AIGCI — which JP Morgan estimates has $25bn in funds tracking it — the new weightings come into force during the roll period that begins January 9th. The S&P GSCI index weightings kick-in after its January roll which commences January 8th. JP Morgan estimates about $50 bn of investment into that index… Accordingly, JP Morgan sees the most significant change coming in the DJ-AIGCI rebalance. Here the market weight of crude oil is expected to increase from 9.6 per cent to 13.8 per cent, gold from 10.8 per cent to 7.9 per cent, copper (COMEX) from 4.5 per cent to 7.3 per cent, live cattle from 6.4 per cent to 4.3 per cent and sugar from 4.7 per cent to 3.0 per cent. Meanwhile, S&P GSCI crude oil weight will go from 32 per cent to 33.8 per cent…Nevertheless, gold tanked on Monday on expectation of a weighting reduction of gold in the DJ-AIGCI Index …This harkens memories of July 2006 when Goldman greatly reduced the weighting of gasoline, which precipitated a huge collapse in gasoline prices ahead of the 2006 midterm elections.

I have no idea why the managers of these indices made these changes, but they are certainly curious. Oil, formerly a 13.1% weighting in 2007, has fallen so precipitously that its now 9.6%. So it could be merely a case of doubling down — adding more Crude now that is 60% cheaper. (I do not buy the conspiracy theories, but I am aware of them).

I consider these contra-indicated: In a time of massive Fed credit creation and Treasury money printing, they oddly want less exposure to Gold. And with the worldwide recession getting worse, they want more exposure to Oil.  Both of these are poorly timed macro-trades.

There are two things I can tell you about the index rebalancing: First, the last such contra-indicated changes were steamrolled over by the market, and cost investors in these indices to miss out on a huge move in Oil via the lower weightings.

Second, it won’t take long before people start to consider the political ramifications of goosing energy prices 2 weeks before the Obama administration is sworn in.

I have no clue what the motivation is for these moves, nor do I knows what what they were in 2006. But they are looking increasingly curious and ill timed. Once is a coincidence. Twice makes you pay close attention. After the third such move, expect to see the index managers dragged before a  Congressional panel . . .

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Previously:
Calling All Conspiracy Theorists! (September 2006)
http://www.ritholtz.com/blog/2006/09/calling-all-conspiracy-theorists/

Blog Spotlight: The Mess That Greenspan Made (October 2006)
http://www.ritholtz.com/blog/2006/10/blog-spotlight-the-mess-that-greenspan-made/

Sources:
Beware, commodity index rebalancing ahead
Izabella Kaminska
FT Alphaville, Jan 05 15:34.
http://ftalphaville.ft.com/blog/2009/01/05/50769/beware-commodityindex-rebalancing-ahead/