LONDON, Sept. 29 — Politics and worries about oil supplies may have caused gasoline prices to go up at the pump earlier this year, but one big investment bank quietly helped their rapid drop in recent weeks, according to some economists, traders and analysts.
Goldman Sachs, which runs the largest commodity index, the G.S.C.I., said in early August that it was reducing the index’s weighting in gasoline futures significantly. The announcement did not make big headlines, but it has reverberated through the markets in the weeks since and some other investors who had been betting that gasoline would rise followed suit on their weightings.
“They started unwinding their positions, and those other longs also rushed to the door at the same time,� said Lawrence J. Goldstein, president of the Petroleum Industry Research Foundation.
Wholesale prices for New York Harbor unleaded gasoline, the major gasoline contract traded on the New York Mercantile Exchange, dropped 18 cents a gallon on Aug. 10, to $1.9889 a gallon, a decline of more than 8 percent, and they have dropped further since then. In New York on Friday, gasoline futures for October delivery rose 4.81 cents, or 3.2 percent, to $1.5492 a gallon. Prices have fallen 9.4 percent this year.
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Unleaded gasoline made up 8.72 percent of Goldman’s commodity index as of June 30, but it is just 2.3 percent now, representing a sell-off of more than $6 billion in futures contract weighting.
Timmons, Heather. “Change in Goldman Index Played Role in Gasoline Price Drop.” The New York Times 30 September 2006.
In short: changing the definition of an index (the G.S.C.I.) had significant effects upon the overall market, in that it contributed (at least in part) to the fall in national gasoline prices. (By the way, I can’t help but note that Henry “Hank” Paulson, the current Secretary of the Treasury, was formerly the Chairman and CEO of Goldman Sachs. Then again, so was Robert Rubin.)
While I am a big fan of index investing, this article reminds me of some of my concerns about the strategy.
First, the definition of an index is controlled by a third party, and this third party may make changes to the index at their leisure. Index funds respond to changes in the index definition by reallocating their assets and other investors adjust accordingly. As this article illustrates, changing the index definition has the power to move markets — an enormous power to entrust to anyone.
Second, there is great potential to profit off the market movement which ensues after a index redefinition. Imagine if the third party which controls the index decided to exploit this profit-making potential.
Third, mutual funds (including index funds) essentially force one to abandon their rights as a shareholder, including the important duty of electing the Board of Directors. A multimillionaire mutual fund manager may have a very different idea of what makes a good Board member than do his middle class investors.
Update 2006-10-02 9:52 AM: Reworded a few paragraphs to try to be a little more balanced and have more sensible inter-paragraph transitions.
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