Does indexing ruin commodities markets?

(MoneyWatch) Active investment fund managers have been arguing that indexing is causing securities to move in tandem. We've seen that the story isn't true for small-cap stocks, and today we turn our spotlight on the commodities markets. By examining the year-to-date returns of individual commodities, we'll demonstrate that the same findings we saw in the stock market hold true across markets and asset classes.

To test whether indexing has affected commodities, we'll look at the changes in prices for some of the commodities within the S&P GSCI Index. (Data is from the beginning of year through Sept. 25.)

  • Silver, wheat, corn and soybeans were all up more than 20 percent
  • Gasoline, gold and cocoa were all up more than 10 percent
  • Cotton and coffee were both down more than 20 percent
  • Natural gas and sugar were down more than 10 percent
  • Crude oil, cattle and hogs had negative returns in the single digits

Clearly, there was a wide dispersion of returns, demonstrating that indexers are no more driving prices in the commodities markets than they are in the stock markets.

Of course, given the wide dispersion of returns, you'll read stories about how investors now need to be more "discerning" about which commodities they should go long and which to avoid. Unfortunately, that is just as much a loser's game as stock picking is. You're best served by ignoring those stories.

If you believe that the diversification benefits of commodities make them worth considering for inclusion in your portfolio, the prudent strategy is to use a lower cost, passively managed fund. I prefer to avoid active strategies, as they cause you to lose control over the risks of your portfolio. There are also a variety of exchange-traded funds that use passive strategies to replicate the returns of various indices.

Money image courtesy of Flickr user 401(K) 2012