DBC: Risks To The Downside Ahead
Philip Baker | Apr 15, 2015 02:37AM ET
PowerShares DB Commodity Tracking ETF (ARCA:DBC) seeks to track changes in the level of the DBIQ Optimum Yield Diversified Commodity Index Excess Return™. The commodities tracked are Light Sweet Crude Oil (WTI), Heating Oil, RBOB Gasoline, Natural Gas, Brent Crude, Gold, Silver, Aluminum, Zinc, Copper Grade A Corn, Wheat, Soybeans, and Sugar.
At around $17.44 currently, DBC is 3.8% above the low end, and 45.4% below the high end of its six year trading range of between $16.81 and $31.92.
Amongst a general downturn in commodity prices this year, DBC has not fared particularly well -
Not surprisingly, as a diversified commodity fund DBC’s volatility has been below that of individual commodities -
As shown below, the volatility of the DBC price has been on the rise -
We have developed a fair value of DBC based on a multiple regression analysis of its price on 22 driver variables including interest rates, stock indices, commodities and exchange rates. The database is six years of daily prices.
The elasticity of the DBC fair value to groups of driver variables is shown in the graph below:
As can be seen, the commodity ETF is positively correlated to the US dollar. This is consistent with natural gas and silver and in contrast with oil and gold which are negatively correlated to USD.
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We have also developed a prediction model based on the lead given by the change in the Baltic Dry Index (BDI) of raw material shipping freight rates. This index is widely seen as a leading indicator of world economic growth, with increases viewed as bullish and conversely.
Based on the BDI lead, it is possible to develop price predictions for a range of commodities, interest rates, stock indices and currencies. These can be combined with the fair value model elasticities shown above to give a predicted movement in the DBC price over the next month. We also backtest the prediction models to assess their value in a trading environment (taking a long position when the predicted price change is positive and a short position when negative).
The predicted price changes for the next month, and the annualized return/volatility ratio over the last six years from trading the predictions, are shown in the following table:
The return/volatility from trading all the predictions combined (of around 185%) compares with that applying to the S&P 500 over the same period, of 102.2%. We consider this to be reasonably robust given the period commences in mid-2009, around the start of the latest bull market in US stocks.
Our predicted movement in the DBC price for the next month is shown in the table below. The contribution of each driver variable to the overall increase is also shown.
As can be seen from the above two tables,we see mild downside in DBC due to commodity price weakness, not offset by US dollar strength.
We also used the BDI model to directly forecast the DBC price movement for the next month. A change of -3.8% resulted, confirming the signal given above. The six year backtest return/volatility ratio from trading this model was 72%.
Diversification benefits could be realized from allocating a component of a US stock portfolio tracking the S&P 500 to DBC traded using the BDI leading indicator as outlined in this article. For a 5% allocation, the ratio would have improved from 102.2% to 104.7% for the last six years.
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