Commodities are all the rage lately.  How are they doing?  Generally, they are ahead for the year-to-date period.

The energy commodity funds are leading the pack. The broad based commodity funds GSG, DJP and DBC, which we reviewed in some detail in a prior article, show middling performance.  The other narrow scope commodity funds are generally doing less well than the broad based funds.

On a three-month basis, the narrow scope funds are generally in negative territory.

Many of the funds currently have too few assets under management and too little trading volume to warrant investment.

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Richard Shaw
QVM Group LLC

Commodities have become an accepted asset class for a significant portion of investors. Ibbotson has performed studies showing that commodities are a beneficial asset class addition to a portfolio.

The ETF/ETN providers have created convenient and low cost ways to invest in a diversified basket of commodities. This article looks at the the iPath ETN (DJP), the PowerShares ETF (DBC) and the iShares ETF (GSG). There are other broad index commodity funds, but at this time DJP, DBC and GSG are the most liquid.

The index differences, underlying assets differences, and entity structure differences create materially different gross total returns and tax liabilities.

The performance charts that follow are linked to the Yahoo Finance site and are up-to-date (daily), even past the date of this publication.

PERFORMANCE

One-Year Chart Comparing DJP, DBC and GSG:

Three-Month Chart Comparing DJP, DBC and GSG:

OTHER LINKED DATA:

You can currently access the Yahoo Finance Main Page, Yahoo Finance Charts, sponsor Fund Fact Sheet and Prospectus for each fund at::

• DJP: Main | Charts | Fund Fact Sheet | Prospectus
• DBC: Main | Charts | Fund Fact Sheet | Prospectus
• GSG: Main | Charts | Fund Fact Sheet | Prospectus

INDEX COMPONENTS AND WEIGHTS:

The weights for the commodities in the funds are rebalanced annually and then vary during the year based on market fluctuations. Up-to-date index composition information can be accessed at these links:

DJ-AIG index | DB index | S&P index

Key differences in the composition of the indices and their methodologies are shown in this chart. They have different numbers of commodities and weight the commodities differently.

At the annual rebalance, the DJ-AIG index (proxy DJP) sets maximum exposure for each individual commodity and each commodity group.

The S&P GSCI index (proxy GSG) does not set maximums, and instead weights the commodities on world production basis.

The Deutsche Bank Optimum Yield index (proxy DBC) resets weights annually at the fixed allocations established in July 1988.

A closer look at the components in the next table shows the specific commodities currently held in the indices (and presumably therefore in the funds) over the April-May 2008 period.

TRACKING THE COMMODITY GROUPS:

There are many commodity group ETFs/ETNs, but few have sufficient assets, volume or length of existence to warrant consideration at this time. The most active of those narrow focus funds representing each of the five commodity groups are:

• USO (oil to represent energy)
• DBA (agricultural crops)
• COW (livestock)
• GLD (gold to represent precious metals)
• DBB (industrial metals)

COMMODITY GROUP PERFORMANCE:

Everybody knows there is some kind of food crisis. Grocery prices are painful. Wal-Mart has rationed rice purchases. Mexico has had tortilla riots due to corn prices. Rice riots have occurred Asia. China introduced laws prohibiting conversion of human food crops to fuel.

However, who would have predicted a 5 standard deviation price move for an index of 60 foods, or a 16 standard deviation move in rice prices. No, that is not a typo. Bloomberg today reported a UN Food Crisis study and related price charts revealing this food Black Swan.

At the core of the definition of Black Swan is an unpredictable and unexpected price move that is way off the chart in terms of standard deviations from the mean.

Since 3 standard deviations theoretically encompasses 99.7% of all observations, 5 to 16 standard deviations is a shocker.

We’ll have to rely on businesses and governments to solve the problem, but as investors we need to be aware that this situation will take away profits from some and make profits for others.

The recent rate of change in prices cannot be maintained, or it would go to infinity soon, but a new world food supply-demand structure may be upon us. We need to understand that theme and identify ways to be on the right side of it.

We encourage a dialog with our readers to develop long and short ideas related to this long-term, high impact theme.

There are obvious immediate opportunities in the futures market, or with ETFs or ETNs dealing with food commodities, such as Powershares DBA (the leading volume pure agricultural investment fund). There are several other ETFs or ETNs, but none currently have sufficient liquidity for safe use. They include funds specializing in grains, livestock, and food generally.

There are probably individual operating companies, or country funds, that will more effectively capture the continuing profit potential for this new world of food; and there are those who will be chronically disadvantaged.

We don’t have a current list of candidates, but will be working on that. What are your thoughts on investing in the face of this food situation?

Richard Shaw
QVM Group LLC