Understanding Commodity Indices

Imagine buying gold and not having to hold on to it physically. Would it not reduce a lot of transportation, storage, and stress for you to resell it to a third party? Let’s not forget the carry costs you will be saving.

This is exactly what a commodity index does.

What is a commodity index?

A commodity index tracks prices and returns on a basket of underlying commodities. These underlying could be a combination of commodities or a single commodity. These indices when available for trading are listed on an exchange. Prices of these indices are based on the underlying set of commodities.  Price fluctuations in an index are based on the proportion of the constituent commodities.

Commodities provide diversification in an investment or trading portfolio. Hence a commodity index would also. A commodity index generally has a low or negative correlation with an equity market.

A commodity index could be considered as an alternate investment vehicle whereby it provides an opportunity to take position in commodity derivatives.

Commodity indices in India

MCX iCOMDEX was launched by MCX in the year 2019. Salient features of iComdex are: -

• MCX iCOMDEX series of commodity indices are excess return indices which consist of a composite index (constituting futures contracts across different commodity segments), two sectoral indices (Bullion Index and Base Metals Index) and four Single Commodity Indices (Gold Index, Silver Index, Copper Index and Crude Oil Index).
• The underlying constituents of all the indices under the MCX iCOMDEX series are liquid futures contracts traded on MCX.

Other indices at MCX

In addition to iComdex, MCX has launched three sectoral indices, viz; BULLDEX, METLDEX and iComdex ENERGY Index. All these indices are available for trading at MCX in the form of Futures. iComdex Energy Index is the latest entrant. All these indices are sectoral indices and represents composite prices of a sector. For example; BULLDEX is based on precious metals (bullion), METLDEX is based on base metals and iComdex Energy Index is based on crude oil and natural gas.

The National Commodity and Derivatives Exchange (NCDEX) also allows trading in one agri-commodity index - NCDEX Guarex. It is based on the liquid Guargum and Guarseed futures contracts traded on NCDEX. The index is designed to provide exposure to Guar Complex Commodity to market participants.

How do I Buy Commodities?

There are three ways to invest in commodities. They are as follows:

• Invest in a commodity directly by purchasing it physically and avoid dealing with a third party.
• Invest in a futures contract by using a brokerage account and meeting margin requirements.
• Rely on Exchange Traded Funds (ETFs) and mutual funds to indirectly invest in commodities and diversify your portfolio.

How do I trade in a commodity index?

One can trade in multiple commodities at the same time either by trading in a commodity index or taking positions in multiple commodities separately. A commodity index is based on the future prices of the constituent commodities in a predefined weight and provides an opportunity to take an exposure in multiple commodities using a single futures contract.

Returns from a commodity index would depend on the weight and movement in the future prices of each underlying constituent.

Why the BULLDEX (Bullion index) is so popular?

MCX BULLDEX is a mix of Silver (30 kg) and Gold (1 kg) futures contract. Any investor who wants to take an exposure in these precious metals, may take a position via a single contract. Investors can also use this to diversify their portfolio because of the low correlation with other asset classes

Even though a commodity index might be a new term in the Indian markets, it’s gaining momentu

Key takeaways:

• A commodity index is a basket of commodities.
• An index evens out the volatility of the constituent commodities and it becomes relatively easier to track different commodities through one index.
• Commodity indices could be used effectively to diversify a portfolio.