Making Use Of A Crystal Ball
By Ranga Nathan, CFA

Many experts have predicted a bull market for commodities over the next decade or longer, and index-ers have rushed out new commodity indexes and funds designed to capture that outperformance.1 The commodities bull market, however, is not expected to occur in a sustained, unidirectional manner, but to be accompanied by price reversals along the way - both for the commodities sector as a whole and for individual commodities.

For an investor looking to capture the best possible performance from the commodities sector, it would be useful to reduce the exposure to-or even go short-individual components when price depreciation can be forecast.
Illustrated by Chuan Koo

Similarly, an investor would want to add exposure again when an upward trend in the price of the component is forecast.

The same is true for financial instruments, including currencies, another important asset class with certain negative correlations to the equities market.

One way to capture these fluctuating returns is through tracking the Standard & Poor's Diversified Trends Indicator (S&P DTI), a composite of price "cyclicality" in major nonequity financial and commodity markets. Initially developed by Victor Sperandeo,2 it is a rules-based, long-short investable trading methodology maintained by Standard & Poor's with guidance from an oversight committee.

Components And Weights

The S&P DTI includes 24 components, divided equally between Financials and Commodities, as shown in Figure 1.3

The Financials include six foreign currencies and two U.S. fixed-income instruments. Allocation among these seven economies is based on, but not in direct proportion to, their respective gross domestic products. See Figure 2 for a comparison of the GDP-based weights and the Indicator weights. Other factors affecting the allocations besides GDP are: (a) liquidity; (b) trading and political significance; and (c) correlation among the seven economies.

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