Analysis of Commodity Indices: Types, Performance, and Risks

In recent years, the investment landscape has shifted dramatically, with a renewed interest in commodities as a means of diversification and inflation hedging. One popular vehicle for gaining exposure to commodities is via commodity indices, which provide a systematic approach to capturing overall commodity price movements. Given this context, analyze the following:

1. Compare and contrast the two predominant types of commodity indices: those based on physical commodity ownership (e.g., spot market indices) and those based on futures contracts (e.g., futures market indices).

2. Discuss the implications of backwardation and contango on the performance of commodity indices based on futures contracts, providing specific examples of how these market conditions can impact the returns of an investor using a futures-based commodity index.

3. Evaluate the potential disadvantages and risks associated with investing in commodity indices, considering factors such as liquidity, market participation, and macroeconomic variables.

Your analysis should demonstrate a strong understanding of the dynamics of commodity indices and include relevant examples to support your arguments.