The CRB Gets Real

May 13, 2005

The world’s most widely recognized commodity index finally makes some sense.

The Reuters CRB Commodity Index is the oldest and best-known commodity index in the world.  When people talk about rising commodities prices, they're usually talking about a rise in the CRB.


But that doesn't mean that the CRB is good measure of commodity prices.  In fact, as Matt Hougan explained in his recent analysis of commodity indexes, the CRB's equal-weighting methodology makes it a particularly bad measure of commodity prices: 


The CRB is a widely followed index, but its methodology raises obvious problems for a commodities investor: Can the price of orange juice really be as important as the price of oil?  


But now, thanks to a new partnership with the investment bank Jefferies Group, the CRB is getting an overhaul.  Looking for an opportunity to build its brand in the commodities space, Jefferies has joined forces with Reuters to revise the CRB index and restore its economic relevance. 


"Jefferies is one of the global leaders in providing commodity index-related products to institutional investors, and the CRB is the most widely followed benchmark for commodities," said Adam De Chiara, co-president of Jefferies Financial Products.  "So (working to revitalize the index) was a natural for us."


The new index will add three commodities, drop one and - most importantly - be reweighted to "take into account the relative significance and liquidity of the various commodities markets."


Hallelujah … the CRB finally got religion.


What's Changed


The three commodities entering the index are aluminum, unleaded gasoline and nickel; platinum is exiting the index.  Those moves are in line with the current thinking in the commodities industry, which is emphasizing energy components and steadily de-emphasizing precious metals.  Jefferies said that platinum is being dropped largely because platinum futures are illiquid.


By far the bigger change to the index, however, comes in how the components are weighted. Scrapping the old equal-weighting methodology, Reuters and Jefferies have come up with a hybrid methodology that attempts to balance diversification and economic relevance.


"Our goal was to maintain a diversified index while also recognizing that some commodities are more economically significant than others," said De Chiera.


The biggest change comes in the weight of crude oil, which jumps from 5.88 percent to 23 percent of the index.  Combined with the introduction of unleaded gasoline, that pushes the energy sector weighting for the index from 17.6 percent to 39 percent.  Industrial metals also get a leg up, while agricultural commodities lose weight.


"The main change was to recognize the importance of petroleum as a commodity," said De Chiera, who said that Jefferies and Reuters looked at the economic importance, liquidity and financial correlation of each commodity to determine their weight.  Oil is famous for being negatively correlated with equity prices, which is a boon in the eyes of commodities investors.


This "soft" approach to weighting the commodities differs from competing indexes, which weight components by either the dollar value of each commodity's production or by the trading volume of the underlying futures contracts, or some combination thereof.  Given the ongoing debate about which technique is better, the CRB's approach might offer an interesting middle ground.


Either way, it represents a significant advance over the old index.  Here's a look at how the sector weightings of the two indexes compare:












Industrial Metals






Precious Metals









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