Selecting asset class components – Commodities

Selecting the commodities component of my portfolio was by far the most difficult of the six asset classes. Broad commodity ETFs and ETNs exist, but they generally have two features that make them unsuitable for tracking commodities prices. The first problem is that the weighting of the commodities that comprise the index can change at the whim of the issuing company. This means that the ETF is essentially tracking a different basket of commodities each time the components change. Secondly, most of the ETFs are too heavily weighted towards crude oil and its derivative products (gasoline and heating oil). For example, DBC, a broad commodities ETF, has a petroleum weighting of 49.5% versus 22.5% for agricultural products.

Jim Rogers highlighted this issue in his outstanding book, “Hot Commodities“.

If fact, Rogers created his own suite of commodity ETNs, RJA, RJN, RJI, RJZ, that reflect his view of a proper construction of commodities indexes. I decided not to use RJI due to my concerns about the viability of ETNs. However, I did use the weighting scheme of RJI as a guide in constructing my own mix of ETFs.

I constructed a commodities index by combining three ETFs: DBC, DBA, and GLD, in a proportion of 12:5:2 respectively. Here is a breakdown of the components:

DBC DBA GLD Composite
petroleum 49.5 31.263
natural gas 5.5 3.474
gold 8 100 15.579
silver 2 1.263
aluminum 4.167 2.632
zinc 4.167 2.632
copper 4.167 2.632
corn 5.625 12.5 6.842
wheat 5.625 12.5 6.842
soybeans 5.625 12.5 6.842
sugar 5.625 12.5 6.842
other 50 13.158
DBC DBA GLD Composite
petroleum 49.5 31.26315789
natural gas 5.5 3.473684211
gold 8 100 15.57894737
silver 2 1.263157895
aluminum 4.167 2.631789474
zinc 4.167 2.631789474
copper 4.167 2.631789474
corn 5.625 12.5 6.842105263
wheat 5.625 12.5 6.842105263
soybeans 5.625 12.5 6.842105263
sugar 5.625 12.5 6.842105263
other 50 13.15789474

Gold is probably over weighted. Originally, I planned to use DBC:DBA:GLD:SLV, 12:5:1:1, but this would have caused me to trade an odd lot of GLD. In the future, I will add SLV. Note that “other” refers to softs and meats.

The 3 ETFs that I chose are all very liquid, thus there are no issues in shorting them. Additionally, their component weightings are stable.

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