Table Of ContentINTELLIGENT
COMMODITY
INDEXING
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INTELLIGENT
COMMODITY
INDEXING
A PRACTICAL GUIDE
TO INVESTING
IN COMMODITIES
Robert J. Greer,
Nic Johnson, Mihir P. Worah
New York Chicago San Francisco Lisbon London
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Seoul Singapore Sydney Toronto
Copyright © 2013 by Robert J. Greer, Nic Johnson, and Mihir P. Worah. All rights
reserved. Except as permitted under the United States Copyright Act of 1976, no part of
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in a database or retrieval system, without the prior written permission of the publisher.
ISBN: 978-0-07-176315-8
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Contents
Foreword vii
Introduction ix
CHAPTER 1 History of Commodity Indexing 1
CHAPTER 2 Drivers of Commodity Index Returns 17
CHAPTER 3 Thinking About Inflation Hedging
and Diversification 35
CHAPTER 4 Intelligent Commodity Indexation Overview 53
CHAPTER 5 The Drivers of Roll Yield 59
CHAPTER 6 Maximizing Roll Yield 81
CHAPTER 7 Calendar Spreads and Seasonal Strategies 103
CHAPTER 8 Substitution 127
CHAPTER 9 Volatility 147
v
vi CONTENTS
CHAPTER 10 Implementation 167
CHAPTER 11 Risk Management 185
CHAPTER 12 Commodity Fundamentals 201
CHAPTER 13 Index Development—The Next Phase 235
Conclusion 249
References 253
Index 255
Foreword
C
ommodities are a relatively unexplored asset class in academia
and indeed the fi nancial markets themselves. While commodity
futures have long been used by producers to hedge crops and future
production, their valuation relative to “spot” prices has been only
lightly explored. When PIMCO initially entered the “fi nancial”
futures markets in the early 1980s, we ordered T-shirts that trum-
peted “Come with PIMCO into the Futures,” and shortly thereaf-
ter we and a small group of clients were off and running on a very
rewarding 30-year journey. Our research and discussions helped
give us an advantage compared to competitors who were glued to the
world of cash securities that in many cases were still kept in a vault.
Financial innovation was PIMCO’s trademark, but at the same time
we made sure to walk a steady path and be wary of the inevitable
derivatives quicksand.
Now, PIMCO portfolio managers Mihir Worah and Nic
Johnson, along with product manager Bob Greer are continuing
that journey with their book Intelligent Commodity Indexing. Respon-
sible for one of the world’s largest commodity practices, they are in
the unique position to explain what makes for value in commodity
futures and to discuss their vision on the future of commodity index
investing, essentially a newer, smarter “PIMCO Index.”
Principles that we at PIMCO have applied to fi nancial futures
have been and are now being applied by our commodity desk. In the
vii
viii FOREWORD
following chapters you will hopefully discover a world of “carry”
and “roll yield” that comes almost directly from our management
of bonds and bond futures. You will read about substitution effects
and their infl uence in terms of contract pricing. Throughout, the
authors reinforce the attractiveness of commodities as an asset class,
which can be used as a hedge against what PIMCO expects to be an
infl ationary future.
I welcome, and take pride in, the following research provided
by this team of veteran PIMCO portfolio managers and hope that
you as well can benefi t from their thinking as we do every day on
the PIMCO trading fl oor.
—Bill Gross, PIMCO Founder and
Co-Chief Investment Offi cer
Introduction
C
ommodities are a mainstream asset class, used by institutional
investors and individual investors alike. This is a major change
from just 35 years ago. Whereas stocks and bonds have been consid-
ered acceptable, at times even conservative, investments for centu-
ries, commodities—or more specifi cally, commodity futures—only
began to attain that status recently. Previously commodity futures
markets were primarily used by commercial parties, who were look-
ing for ways to hedge price risk. Indeed, that hedging function is
the reason commodity futures markets developed in the fi rst place.
Historically that risk was assumed by speculators, who in fact were
in the markets to make a profi t by guessing the direction of price
movements, often using leverage and giving the futures markets the
reputation of being extremely risky.
Relatively recently, investors began to understand that these
markets offered opportunities for infl ation hedging and diversifi ca-
tion as well as the potential for meaningful returns. Those benefi ts
especially began to be appreciated after the stock market decline
that began in 2000. As investors were drawn to this asset class, they
needed a way to defi ne just what “commodity investment” was.
Like every asset class, commodities needed an investable index.
There had been for many, many decades various measures of cash
commodity prices, but investors now weren’t typically buying cash
commodities—they were buying commodity futures.
ix
