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NatGas surge weighs heavily in commodity indices
Commodities
Ole Hansen
Head of Commodity Strategy
Résumé: US Henry Hub Natural gas has following a 160% year-to-date surge become the biggest component in the Bloomberg Commodity Index, and it highlights just how extreme market moves and developments have been during the past year across the commodity sector. In this we look at what it means and what investors in commodity tracking funds should be aware of
US Henry Hub Natural gas (ticker: NG) has following a 160% year-to-date surge become the biggest component in the Bloomberg Commodity Index (BCOM), the first time this has occurred in the index’ +30 year history, and it highlights just how extreme market moves and developments have been during the past year across the commodity sector.
The BCOM index which together with the S&P GSCI and DBIQ Optimum Yield Diversified Commodity Index belongs to the heavy weights within the global investment industry, tracks the performance of 23 major commodity futures targeting a one-third exposure in the main sectors of energy, metals and agriculture. The target weights are set once a year every January and if prices shift significantly during the year, a reweighting will not occur until the following January.
The mentioned 160% year-to-date surge in US natural gas futures has more than doubled its weight to 17.2% from 8%, and in the process made it the biggest component in the BCOM index, more than double that of WTI and Brent combined. From a sector perspective, and given strong gains across the other energy components, especially fuel-based products, it has lifted the total energy exposure by 9.2% to 40.9%. All other sectors and sub-sectors share the reduction with the biggest seen in metals with industrial and precious down by a combined 7.5%.
What it means?
The BCOM index is likely to become more volatile with its performance increasingly dependent on developments within the energy sector, especially natural gas. Recently the price hit $10 per MMBtu before suffering a 10% setback due to a further delay of the restart of the Freeport LNG export plant which has been closed for months following an explosion. The expected restart will increase demand for US gas and with that slow the process of adding stockpiles before the winter extraction season starts in a couple of months’ time.
The biggest threat to the energy sectors strong performance is the combination of a deep recession eroding demand and a peaceful solution to the war in Ukraine sending EU gas prices sharply lower in anticipation of flows from Russia normalizing.
What should investors in commodity tracking ETF’s do?
The short answer is nothing as the reasons for investing in tangible assets such as commodities has not changed. The other commodity tracking funds mentioned earlier, and which also include the CRB Index will all be affected depending on their individual exposure to natural gas. Overall, the BCOM has from the outset the largest exposure and is therefore the index impacted the most. From an investor perspective these types of futures tracking commodity funds remains a cheap solution to gain exposure to commodities. With natural gas being notoriously volatile some increased price swings on the index can be expected, and if the strong gains are being maintained we should expect a very active rebalancing next January where gainers will be sold, and losers bought in order to reset the target weights.