Advantages and Disadvantages of Commodity Indices

In recent years, commodity indices have gained popularity among investors looking to gain exposure to commodities while mitigating some risks associated with investing in single commodities. A commodity index is designed to track the performance of a predetermined group of commodity futures contracts, and the index value fluctuates based on price movements of the underlying commodities.

Discuss the advantages and disadvantages of investing in commodity indices compared to investing directly in individual commodities. In your response, address the following points:

• The role of diversification in commodity indices.
• The impact of contango and backwardation on commodity indices.
• Liquidity and transaction costs associated with investment in indices versus individual commodities.

Use specific examples to support your argument.