Dow Jones Launches 3-Month Forward Commodity Indexes

September 28, 2007

ETF Securities plans to launch ETFs based on the indexes.

On Tuesday, Dow Jones Indexes launched a large group of "three-month-forward" commodity indexes based on the sector and single-commodity subindexes of the Dow Jones-AIG Commodity Index (DJ-AIG). Rather than tracking a rolling position in current-month futures contracts, the new indexes track the performance of contracts dated out three months. In other words, rather than holding the November contract for oil today, the new indexes hold the February contract instead. Next month, they will roll into March.

ETF Securities Ltd. (ETFS), a European exchange-traded fund (ETF) provider, plans to launch 10 index-linked ETFs based on these indexes in the coming months, covering the broad-based DJ-AIG and nine of its commodity subsectors: softs, ex-energy, livestock, grains, agriculture, energy, petroleum, precious metals and industrial metals subindexes. An ETFS spokesperson said that subsequent launches of products based on the single-commodity indexes would be determined by demand.

This is hardly the first effort to measure performance further out the commodities yield curve. In the United States, Victoria Bay Asset Management has filed papers for an ETF that would track the blended performance of the next 12 months worth of oil futures contracts. More immediately, funds like the PowerShares DB Commodity Index Tracking Fund (DBC) have roll mechanisms that allow them to opportunistically move out the commodities yield curve when doing so is advantageous.

Many of these products were launched in the aftermath of the vicious contango that gripped the energy markets through mid-2007. That contango was focused on near-term futures contracts, and created a major headwind for the performance of the basic commodity indexes. The thinking behind the development of some of these new indexes was driven at least in part by the hope that the out-month futures contracts would partially sidestep the contango issue.

Now, of course, that contango has subsided ... and in fact reversed ... and we're left with a backwardated market in which the traditional indexes may perform better than these new indexes. Right now, for instance, the roll yield between the November and December crude oil contracts is 1.8%, while the roll yield between February and March is just 0.5%.

Still, these forward-contract indexes are a nice addition to the market, as they insulate investors from the ebb and flow of current-month contract trading and demand. In fact, by reducing the impact of contango and backwardation, many believe that these indexes will track closer to the underlying spot price of the commodities ... something that appeals to many investors.

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