Commodity Online
The two commodity indices with the largest amount of fund money linked to them, the S&P GSCI and the DJ-AIG, will rebalance their holdings in early January. This will involve the purchase and sale of futures contracts.

Based on current prices, we expect the changes will be relatively small for most commodities. As a % of open interest the commodity to see the largest sale is lean hogs, with 20,703 contracts sold equivalent to 12% of open interest, followed by live cattle at 8%, and sugar at 7%. The largest purchase is Comex copper at 21% of open interest (16,780 contracts); however, as a guide to market impact, this might be overstated due to the extra copper market liquidity afforded by the LME contract (which will see a tiny rebalancing). Next largest purchase will be LME nickel at 9% of open interest, followed by LME zinc at 6% of open interest.

These forecasts will change between now and early January in line with changing relative prices and the number of contracts held by the indices. Given the volatility of prices in recent months this implies greater uncertainty for these forecasts than in previous years.

The announcement recently by S&P GSCI of the new contract production weights (CPWs) for their market-leading GSCI index, following on from August's publication of the Dow-Jones AIG Index's 2009 target weights, means we now have a reasonable idea of what the two main commodity indices rebalancing will mean when it happens in January 2009.

To recap, as commodity indices purchase futures, and the data (at least for the agricommodities) from the Commodity Futures Trading Commission (CFTC) in the US shows that these can account for up to half of the open interest in those
markets of which we estimate these two indices probably account for 90% then this rebalancing will have a direct and immediate impact in early January on the volume of contracts bought or sold in the commodities contained in theirbaskets.

This can obviously also impact the futures price of these commodities, although it is conceivable that, by January 2009, the futures prices may have already adjusted themselves, in the light of the expected rebalancing of these indices.

It's worth noting that these indices are not what they once were. Their assets under management (AUM) has declined from a peak of around $200bn in early July 2008 to at most $100bn now, according to our estimates, based on CFTC data and other public sources. Some of this decline is due to falling commodity prices, but so too was the increase seen in early 2008. In terms of contracts held, the indices are probably now back at levels not seen since early 2006.

The largest index, the S&P GSCI, which we estimate has $60bn-$65bn in AUM, announced its new weightings on 3rd November. These will be implemented during the first roll period, which will be the between the 5th and 9th business day of January, which is the 8th-14th January.

We expect the impact on all commodities from this re-balancing will be relatively small, due to the nature of the S&P GSCI. The weightings tend not to vary by much, as they are chosen primarily on the basis of the average of each commodity's production in the five most recent years for which data is available, a calculation in which the price prevailing in those five years does not matter.

Thus the weighting of each commodity in 2009, compared with 2008, will reflect the relative differences in their average production between 2000-2004 and 2001-2005. Commodity production rarely varies enormously from year-to-year, and three of the five years being averaged will be the same; therefore the changes in weightings do not tend to be large.

This time around we believe the largest % change will be in WTI crude oil, gaining 0.43% points, and Brent crude oil (BRT), losing 0.36% points. But even these, in terms of contracts compared with the size of the overall market, are not large.

The Dow-Jones AIG Index is the second largest commodity index by AUM, with an estimated $30bn-$35bn in funds tracking it. It announced its new weightings in August. These will come into force during the roll period that begins on the 6th -10th working day of 2009, which is 9th -15th January.

With the DJ-AIG Index there is more potential for large changes than in the GSCI, because its weightings are set not in terms of ounces/tonnes, but by dollar value (each commodity is allocated a percentage share of the total value of the index), based two-thirds on rolling five-year dollar value averages for liquidity (contract volume traded), and one-third rolling five-year dollar value averages for production.

This means there are two factors behind the extent of the rebalancing required by the DJ-AIG Index, the change in the target weighting, and the change in the price of a commodity since the last rebalancing. The latter factor can be large. It means that, even if the target weights of the index remained unchanged, rebalancing would still occur, as the actual weighting would have changed in line with relative price movements.

We cannot know the extent of the rebalancing that will happen in the DJ-AIG Index until we know the prevailing prices for each commodity on 7th January 2008.

There are numerous commodity indices for investors. Although the GSCI and Dow-Jones AIG are by far the largest in terms of AUM, the weightings of some particular commodities in the other indices might be considerably higher, and thus their investment in those commodities could be relatively large.

Despite these issues, our estimates made this time last year were remarkably accurate when matched against the data on index funds that is available, the CFTC's CIT report for 12 agricommodities. Only cotton and to a lesser extent live cattle were noticeably out.

Courtesy: Fortis Metals Monthly