Since food and energy typically represent a higher percentage of commodity indices than of the CPI, one dollar of investment in a commodity index provides a basis for more than one dollar’s worth of inflation protection. In this chart, the inflation beta can be interpreted as a 1% increase in inflation results in 11.0% increase in return of the DJCI and a 15.3% increase in return of the S&P GSCI during the period from 2000 through 2013.
Notice the S&P GSCI increase in inflation beta of the S&P GSCI from 2.8 to 13.0 in the time period that starts in 1971 versus the time period starting in 1987. This increase is directly from the addition of oil into the index and is no surprise since energy is the most volatile component of CPI and energy is used to produce every other commodity. The world production weighting scheme of the S&P GSCI that yields a higher energy weight results in a greater inflation beta than the DJCI, though the inflation betas of over 10.0 from the DJCI are significant.
This also holds true for inflation betas around the world, except in places where the prices are independent of the economy. For example, the Mexican government sets the price of gasoline so returns of commodity indices are not considered an inflation hedge against changes in Mexican CPI. This is shown in the chart below:
Overall, from the analysis, both the S&P GSCI and the DJCI are strong inflation protectors. However, the S&P GSCI is a stronger inflation hedging tool given its energy weight.
This article was written by Jodie Gunzberg, global head of commodities, S&P Dow Jones Indices.
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