Why Be Long The Goldman Sachs Commodity Index?
Follow-up No. 2 / August 12, 2005
Peter Zihlmann
A Broad Spectrum of Commodities
The GSCI contains as many commodities as possible, retaining only those that promise liquidity and investability in the underlying futures markets. Currently, the GSCI contains 24 commodities from all commodity sectors:
- six energy products
- five industrial metals
- eight agricultural products
- three livestock products and
- two precious metals.
Goldman Sachs Commodity Index
The GSCI is designed to provide investors with a reliable and publicly available benchmark for investment performance in the commodity markets comparable to the S&P 500 or FT equity indices. As such, the GSCI is a composite index of commodity sector returns, representing an
un-leveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully-collateralized basis with full reinvestment. The combination of these attributes provides investors with a representative and realistic picture of realizable returns attainable in the commodities markets.
Individual components qualify for inclusion in the GSCI on the basis of liquidity and are weighted by their respective world production quantities. The principles behind the construction of the index are public and designed to allow easy and cost-efficient investment implementation. Possible means of implementation include the purchase of GSCI-related instruments, such as the GSCI futures contract traded on the Chicago Mercantile Exchange (CME) or over-the-counter derivatives, or the direct purchase of the underlying futures contracts.
The ten-year picture
What the above chart indicates is that commodity prices moved up from 1994 to the end of 1996, from the start of 1999 to the end of 2001 and from October 2001 to the present day. However, within the present up-trend, we need to be cautious as most indicators signal an over-bought situation.
Nevertheless, a substantial rise in commodity prices during the next decade is a significant likelihood.
Commodities are bargains!… and as good as gold ( see above chart!)
If "buy low, sell high" makes any sense at all, this is the time to buy. As the chart below suggests, the secular decline in commodity prices has come to an end and a reversal is in progress. As commodity prices move back up to "normal" levels, they will attract additional investors into what is a relatively small arena. Even a tiny asset allocation shift from stocks/bonds into commodities could give a pronounced boost to commodity prices.
One key factor worth noting is the falling US dollar. If the US dollar continues to weaken, prices will rise to compensate. A trend of rising prices tends to attract more investors and they could push prices higher still. Eventually this process could develop into a classic spiral of rising prices such as occurred during the 1970s.
Nevertheless, while the US-Dollar has fallen by close to 25% against a basket of other currencies since 2002, commodity prices as per the GSCI have risen close to 100%. Furthermore, the short-term strengthening of the US-dollar seems to have run its course.
But for most, the rationale behind rising commodity prices is simple:
- Demand for basic commodities increases as the world's population (growing by close to 100 million people each year) strives for improved lifestyles.
- The emergence of China as a super economic power: China will have a huge impact on the world's commodity markets and is likely to push commodity up prices considerably.
- As a consequence, supply cannot meet demand.
World Population: 1950-2050
The long-term picture
Judging from the long-term trend, we can safely conclude that the up-trend is well established, although there have been buying AND selling opportunities on the road.
Taking a pragmatic stance, we know that the up-trend is intact BUT that various indicators are beginning to signal an over-bought market. The Index may indeed move higher from the present level but we advise taking at least partial profit.
The medium- to short-term picture
After the rise of more than 20% since May, today's question is when to sell rather than when to buy. While we have not yet reached an excessively over-bought level, it is good to remember that what goes up may also come down.
Investing in the GSCI
The GSCI is a publicly available index and freely licensed to all market participants.
The GSCI has a futures contract listed on the CME making it a truly public and non-proprietary index that has been traded by numerous market makers for over 12 years.
An investment in the GSCI provides access to the liquidity of the underlying commodity markets and offers excellent price transparency.
Goldman Sachs Commodity Index Futures Specifications
Name and Symbol: Goldman Sachs Commodity Index (GSCI), Chicago Merc, GI
Contract Size: $250 x Goldman Sachs Index (roughly USD 85,000) Minimum Tick Size and Value: 0.05, worth $12.50 per contract.
Trading Hours (Chicago time): Open-outcry trading is conducted from 8:45 AM until 2:15 PM. Globex offers electronic trading of the GSCI from 2:30 PM until 2:00 PM the following day, Sunday through Thursday.
Available Trading Months: GSCI futures can be traded year-round. RISK Guessing the future is ALWAYS risky! However, with a bit of discipline, you may turn the odds in your favor. But for most, the real obstacles to success are greed and fear which can provoke irrational decisions.
If you buy one contract of a GSCI-future worth USD 85,000 and you panic when it goes down 10% or 20%, you should not even start investing.
Conclusion
While in the short-term we are approaching an over-bought market situation, we remain confident that we are in a secular bull-market which may last several years. Our recommendations were valid at the time of writing, viz. at
and may not necessarily hold at the time of reading.
Peter Zihlmann
www.pzim.com
www.timeless-gold.com
investment@pzim.com
forex@pzim.com
August 12, 2005
Disclosure: The author has not been paid to write this article, nor has he
received any other inducement to do so. The author is a shareholder in the
company and will benefit from any increase in the company's share price.
Disclaimer: The author's objective in writing this article is to invoke an
interest on the part of potential investors in this stock to the point where
they are encouraged to conduct their own further diligent research. Neither
the information, nor the opinions expressed should be construed as a
solicitation to buy or sell this stock. Investors are recommended to obtain
the advice of a qualified investment advisor before entering into any transactions
in the stock.
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