About this Episode

Thirty years is an eternity in market terms, particularly if the market in question is the commodities market. Fiona Boal, Global Head of Commodities and Real Assets for S&P Dow Jones Indices, joins the Essential Podcast to talk about the 30th anniversary of the GSCI, supercycles, the energy transition, and the idiosyncratic nature of commodities markets in general.

The Essential Podcast from S&P Global is dedicated to sharing essential intelligence with those working in and affected by financial markets. Host Nathan Hunt focuses on those issues of immediate importance to global financial markets – macroeconomic trends, the credit cycle, climate risk, energy transition, and global trade – in interviews with subject matter experts from around the world.

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Show Notes

• Fiona Boal is Head of Commodities and Real Assets at S&P Dow Jones Indices (S&P DJI). She is responsible for the product management of the commodities, real asset, and housing price indices, including the S&P GSCI, Dow Jones Commodity Index (DJCI), S&P CoreLogic Case-Shiller Home Price Indices, and S&P Real Assets Indices. These indices are leading measures of the commodities market, U.S. residential real estate prices, and composite real assets.

• After three decades of helping investors make more informed decisions and providing index-based access to diversification, liquidity, and inflation protection - what’s next for this index icon? Watch S&P Dow Jones Indices' latest Index TV video capturing the past, present, and future of commodities with the S&P GSCI in honor of the index's anniversary.

• When the S&P GSCI launched April 11, 1991, the S&P 500 closed at 380 and a barrel of crude oil was worth $21. Over the next 30 years, oil would peak near $146, the S&P 500 would cross 4,000, and the broad commodities market would respond to a rapidly changing world that saw the emergence of BRIC countries, the ebbs and flows of tensions in the Middle East, and a range of other geopolitical forces and natural events that caused sometimes-dramatic shifts in commodity supply and demand. Throughout it all, the S&P GSCI remained a steadfast measure of market changes. Made up of the most liquid commodity futures and world-production weighted, the S&P GSCI is a straightforward yet sophisticated measure of commodity beta. Since its inception, it has reliably served as a tool to improve diversification while also offering liquidity and the potential for inflation protection.

Transcript

Nathan Hunt: This is The Essential Podcast from S&P Global. My name is Nathan Hunt. Indexes, like the famous S&P 500 serve as benchmarks of openness and transparency. They are in some ways the yardstick by which a market measures itself. Commodities markets are different, uniquely challenging, frequently opaque, closed to everyone, but a group of knowledgeable insiders. Commodities would seem like an odd fit for an index and yet, for 30 years, S&P Dow Jones Indices has been providing a family of indices for commodities markets. The unexpected longevity and success of those indices are what I'm hoping to talk to my guest about today.

Fiona Boal: My name's Fiona Boal, I'm the head of commodities and real assets at S&P Dow Jones Indices,

Nathan Hunt: Fiona, this is your second time on The Essential Podcast. Last time we talked about gold markets during the pandemic, and now you're back to talk about the last 30 years in commodity markets. Welcome back.

Fiona Boal: Thank you for having me, Nathan. It's great to be back.

Nathan Hunt: It's been 30 years for the GSCI. Let's start with the basics. What does GSCI stand for? And what is it?

Fiona Boal: The S&P GSCI started its life as the Goldman Sachs commodity index, and it was purchased by S&P Dow Jones Indices back in May 2007 and over that 30 years it's really paved the way in terms of index innovation in the commodity market. And today, just as it was when it launched in April 1991, it's the most widely recognized commodity index benchmark. It's broad-based and its production weighted and that means it really is a true global representation of commodity market beta.

Nathan Hunt: Fiona, I just finished reading the book, 'The World for Sale', which is an absolutely ripping account of commodities trading from the end of the second world war until today. Clearly, commodities markets are unique. What are some of the peculiarities of the commodities markets that the GSCI tries to address?

Fiona Boal: You've got that, right. They really are a very unique asset class. At a really basic level, I like to think of commodities as the building blocks of the real economy. By their nature, they're standardized physical assets that are in demand and can be supplied without any real substantial product differentiation across markets. So, copper produced in one region is relatively similar to copper produced in another. But even though they share these common characteristics, they're not homogeneous. You know, there's not much market beta when you talk about core and copper crude oil or coffee. So, they are certainly a hodgepodge of assets that do have some commonality. They're also not what I would call anticipatory assets, what they reflect or what their prices reflect are real-world spot, supply, and demand conditions. They also don't provide an income stream, which can make them pretty difficult to value. Certainly, when you're comparing them to something like equity or fixed-income instrument. And the GSCI does a few things to try and address these unique characteristics. Its production weighted, which means that it really reflects the importance of each commodity in the real world. And that ensures that investors are capturing a true commodity market beta. The other major idiosyncrasy with commodities is that by definition, they're difficult and costly to buy, sell, store. Particularly as an investment. If we think about it, you know, it would be rather tricky and expensive for an asset manager to buy and sell truckloads of live cattle or barrels of oil and the S&P GSCI solution to this dilemma is that it's a futures-based index, which ensures that its constituents are based on liquid futures, contracts that are transparent and tradable and easily accessible for investors.

Nathan Hunt: Both my father-in-law and my brother-in-law are commodities traders. So, I've got, you might say commodities in the family. Is the GSCI for these kinds of commodity specialists? Who is using the GSCI and how are they using it?

Fiona Boal: The S&P GSCI family is really integral to the world's investment infrastructure and it can be used as a benchmark, it might be used to define an investible universe, or measuring a unique return stream from a specific commodity, such as oil or a specific commodity strategy. And so, while your family members, as physical commodity traders might use the S&P GSCI as a benchmark, as a way to sort of look at the direction of a broad basket of commodity prices. The primary use of the headline S&P GSCI is as the basis of financial products and they might be swaps, exchange, traded products, or structured products. Maybe I could give you an example, a pension fund might be looking to allocate a small percentage of its portfolio to commodities in order to benefit from the diversification or maybe the inflation protection qualities that have traditionally been associated with commodities and the way they could do that would be to buy an ETF that is based on the S&P GSCI or enter into an over-the-counter swap on the S&P GSCI with a counterparty, such as a bank. So, what these products allow investors and other market participants to do is to take a position in the commodity market, as we said, without having to go out and buy a truckload of live cattle.

Nathan Hunt: The S&P 500 index really has become synonymous with equity markets. Does the GSCI enjoy a similar reputation in commodities markets?

Fiona Boal: It sure does. I think the S&P GSCI is the equivalent of the S&P 500 in the commodity world. It's certainly widely regarded as the most precise benchmark for world commodity markets. And I go back to this fact that it being world production weighted means that it really does represent the size and the weights of the most vital commodities traded today. Just like the S&P 500 is a market-cap-weighted and represents the true size and weights of the 500 largest companies in the U.S. And also similar to how the S&P 500 is ever-evolving with companies periodically being added or dropped the S&P GSCI is reconstituted based on changing market conditions and that way it is always representative of what the broader global commodity market looks like.

Nathan Hunt: Speaking of changing market conditions, let's talk supercycles. This is a phrase that gets thrown around a lot, helped me with a definition and an example of a commodity Supercycle.

Fiona Boal: Super cycles are not unique to commodity markets. I think the nature and the prolonged mismatch between commodity supply and demand does mean that there is a reasonable history of them in these markets. So, put simply a commodity Supercycle is a sustained period of abnormally strong demand growth that the commodity producer struggles to meet. So, supply takes a very long time to catch up to demand. And this sparks a rally in prices and the rally in prices can last for years or sometimes can last for a decade or longer. You know, for some market participants, the current rally that we are seeing in commodity prices is rekindling those memories of the Supercycle that we saw during China's rise to being an economic heavyweight back in the early 2000s. That was also sometimes referred to as "the peak oil Supercycle."

Nathan Hunt: Looking at the performance of the GSCI over time, I see this big run-up. From around 2002 through the great financial crisis in 2008, the run-up of peak oil, the run-up of the transformation of the Chinese economy. Is that the commodity Supercycle that you're talking about?

Fiona Boal: Yeah, look, I think that's reasonable to say that the commodity boom of the early 2000s was based on two key principles. The first being the concept that non-renewable natural resources are finite, but that the consumption of those resources might not be. So, we might be in a period where we can never catch up to demand. Now at the end that didn't prove to be the case, but there is little doubt that population growth and consumption during that period, put pressure on the availability of physical commodities and it was physical commodities across the spectrum, whether that be agricultural commodities, whether that be the industrial metals that were needed for infrastructure spending or whether that was the energy commodities needed to power power-plants, and, and to meet that increased Chinese demand for cars and things like that. Given the lag that's associated with supply during that period, commodity producers really struggled to fulfill that surging demand for natural resources. And so, I do think that fits the correct definition of a Supercycle.

Nathan Hunt: There has been a lot of talk about a new commodity Supercycle beginning now. What do market participants need to consider when looking at commodities markets today and incorporating commodities into their market portfolios?

Fiona Boal: An area that's really gaining traction at the moment with market participants is the concept of inflation and I think this is all related to what we're seeing in terms of the price action in the commodity markets. One of the most common justifications for having an allocation to commodities in a diversified portfolio is that commodities have traditionally proved to be a relatively reliable hedge against inflation. They've demonstrated what we call a high inflation beta. And I think today, among market participants, the risk of inflation centers around with the recovery, you know, post-COVID 19 recoveries will be truly inflationary. And that's not something that we've seen in the market really for many decades. And even though we might think that the trajectory of real asset inflation might be lower this time around because of structural changes in the economy, whether they be around demographics, the surge in technology, changing production processes, changing consumption patterns. We're starting from a really low base, so even a small increase in inflationary pressure could lead to notable asset repricing and commodities would be very likely to benefit in that period. So, whether we're in a super-cycle or not, I think remains to be seen, but there is certainly a lot more interest in commodity markets at the moment and one of the reasons for that is this growing fear of inflation.

Nathan Hunt: Some, market observers have suggested that commodity needs around the energy transition will lead to another Supercycle. What has been your approach to the energy transition for the GSCI?

Fiona Boal:  I think it's pretty clear that the technology used to sort of mitigate or reverse the effects of climate change is expected to play a vital role in the commodity markets. If you think about it, sort of besides the rare earth metals, the building blocks of many of these technologies are industrial commodities, such as copper, aluminum, nickel, silver. In fact, according to a recent world bank report, over 3-billion, tons of minerals and metals will be needed to deploy the wind-solar, and geothermal power, as well as the energy storage necessary to achieve a below two degrees Celsius future. It's really interesting because historically technology has actually worked against commodity prices either by encouraging substitution or improving productivity and thereby requiring less of raw material to meet the demand. But I think in the case of de-carbonization, the opposite is almost true. The adoption of green technologies might signal a really strong demand for some commodities. From a product perspective, we offer a number of indices across the energy transitions spectrum. For example, we have the S&P GSCI light energy, which is a less energy-intensive commodity market measure. Or one of our most important and popular indices launches from last year was actually the S&P GSCI carbon emission allowances index, which offers a transparent and replicable measure of the performance of the European carbon emission allowance market. And that's the world's most advanced liquid carbon market and that's been a really popular and important addition to the S&P GSCI family for us.

Nathan Hunt: So, speaking of climate, what about ESG? Historically commodities have been a tough mix with ESG. They're frequently dirty to extract, dirty to process. And then there are all of the social issues involved.

Fiona Boal: Arguably it really is the elephant in the room for commodity markets and for commodity investors in terms of how do they incorporate ESG metrics into their commodity investment decisions? It might be possible to apply, say a carbon footprint type analysis and other ESG risk metrics to the underlying commodity such sustainability metrics really weren't developed for specifically these types of financial instruments. So, we don't really yet know where this debate will land, but we know we can't live without commodities. And we know that commodity market participants should be advocating for more efficient and more sustainable production and consumption measures at S&P Dow Jones indices were committed to really leading that conversation regarding the adoption of ESG principles in the commodities arena.

Nathan Hunt:  Looking back and looking forward, how has the ecosystem around the S&P GSCI evolved over the last 30 years and where is there still potential for growth?

Fiona Boal: 30 years is a lifetime in investing, and there's definitely been a large number of Marquis commodity index solutions that we brought to the market over that period. And we expect that the next 30 years could bring even more disruptive changes to commodity indexing.

So far this year we've launched the first S&P GSCI alternative risk premia indices. And for those investors concerned about inflation we've just very recently launched a version of the S&P GSCI, where the collateral yield is determined by the performance of the U.S. treasury tips market. There are a few things to think about as we go forward, we certainly think that the incorporation of ESG principles in the commodity derivatives markets will be a focus along with the growing importance of commodity demand from green technology, which I also spoke about. But the other area that's really interesting and we think will be increasingly important is cryptocurrencies and tokenization. And we think that represents both an opportunity and a threat to commodity indexing. As an alternative asset class, there will be many market participants who think that certain cryptocurrencies could actually offer some of the diversification and the inflation protection benefit similar to commodities, particularly when you're thinking about gold. Well, the tokenization of real assets has the potential to address many of the barriers to real asset investing and broaden out the potential investor base for alternative assets. And we also think that digital ledgers and tokenization may disrupt and potentially improve the efficiency of risk management in the commodity market for the commodity producers and consumers. And importantly, we expect it will likely change the way that commodity derivatives are traded. So certainly, they're the areas that we think over the next few years will be increasingly important to the commodity indexing space.

Nathan Hunt: Fiona. It is always such a pleasure. Thank you so much for joining me.

Fiona Boal: Thank you for having me, Nathan,

Nathan Hunt: The Essential Podcast is produced by Molly Mintz with assistance from Kurt Burger and Lundon Lafci at S&P Global we accelerate progress in the world by providing intelligence that is essential for companies, government, and individuals to make decisions with conviction. I am Nathan Hunt from my home studio high above Manhattan's Greenwich Village. Thank you for listening.

The Essential Podcast is edited and produced by Molly Mintz.