Beyond the Benchmarks: Exploring Diversification Within Commodity Markets

In today’s volatile markets, achieving true portfolio diversification means looking beyond traditional asset classes. While indices such as the Bloomberg Commodity Index (BCOM) or the S&P GSCI Index (SPGSCI) offer a convenient and accessible benchmark for commodities exposure, investors can unlock further diversification potential and potentially enhance returns by exploring niche commodity markets that are not represented in the main commodity indices. This article introduces some of the contracts available on our platform that could match this profile. 

Commodities are widely recognized for their diversification benefits, offering a potential hedge against inflation and often exhibiting low correlations with traditional asset classes. However, many investors focus primarily on broad commodity indices, overlooking the potential for enhanced diversification within specific commodity sectors. Incorporating smaller commodity markets, characterized by reasonable liquidity and distinct supply/demand drivers, can further optimize portfolio diversification and potentially unlock attractive risk-adjusted return opportunities.

To illustrate the diversification benefits, let’s first examine the historical correlations between BCOM, the S&P 500 Total Return index (representing U.S. equities performance), and a representative fixed income index (here the Bloomberg U.S. Treasury index). 

As the data demonstrates, the BCOM has exhibited a varying degree of correlation with both the S&P 500 and treasury markets. Correlation with equity markets has been strong at times, but we have also witnessed strong reversals and periods of near zero, or even negative, correlation. This means that when stock prices fall, commodity prices would rise or remain stable, providing a counterbalance to portfolio losses. Similarly, during periods of rising interest rates, which negatively impact bond prices, commodities can offer an alternative source of returns as they are driven by unique supply and demand dynamics, often influenced by global macroeconomic factors, inflation, weather patterns and industry-specific trends. 

This historical pattern of low correlation underscores the potential diversification benefits of incorporating commodities into a portfolio. By including assets that don’t move in lockstep, investors can potentially reduce overall volatility and improve risk-adjusted returns. This is particularly important during periods of market turbulence, when diversification can help mitigate losses and preserve capital. While indices such as BCOM and SPGSCI provide broad commodity market exposure, relying solely on these benchmarks may leave valuable diversification potential untapped. Let’s consider a few examples of our listed commodity markets that do not qualify for inclusion in the main commodity indices yet offer diversification potential and a reasonable liquidity profile:

Agricultural Markets:

• Dairy (DC) futures: Dairy prices are driven by a complex interplay of factors, including weather patterns affecting milk production (heat stress can reduce output), feed costs (such as corn and soybeans) and global dairy demand. This unique combination of drivers sets milk apart from other agricultural commodities and offers diversification potential within the agricultural sector. Seasonality also plays a role, with milk production typically higher in spring and lower in fall.
• Lumber (LBR) futures: Linked to the housing market, lumber prices are influenced by housing starts, renovation activity and commercial construction. These factors are often driven by interest rate policy and general economic conditions, making lumber a useful diversifier within the broader commodity complex as well as a potential leading indicator. There is also a seasonal component to lumber prices, with more construction activity after the winter as the weather improves.

Metals markets:

• HRC Steel (HRC) futures: U.S. domestic HRC steel, essential for construction, manufacturing and automotive industries, provides exposure to a broad range of industrial activity. Its price dynamics are linked to raw material costs (iron ore, coking coal), global economic growth and specific industry trends, such as infrastructure spending and manufacturing output. This makes HRC steel a valuable diversifier, offering exposure to a different set of economic drivers than traditional financial assets.
• Lithium (LTH) futures: Essential for batteries used in electric vehicles, consumer electronics and grid-scale energy storage, lithium provides exposure to the rapidly growing electric vehicle and renewable energy sectors. Lithium prices are influenced by supply chain dynamics (mining and refining capacity), technological advancements in battery technology and government policies supporting clean energy adoption – Lithium Commodity futures offer exposure to a high-growth sector with distinct drivers.

Energy markets:

• Ethanol (CU) futures: This biofuel’s price is tied to corn and sugar prices (the key feedstocks), government regulations (such as blending mandates and subsidies) and gasoline demand. This creates a distinct profile within the energy complex, offering diversification away from traditional fossil fuels. Furthermore, ethanol prices can be influenced by agricultural market conditions and policy changes, adding another layer of diversification potential. 
• Propane (B0) futures: Used for heating, cooking and as a petrochemical feedstock, propane demand is highly sensitive to weather patterns, particularly during winter months. This seasonality offers a diversification angle, as propane prices can fluctuate independently of broader energy market trends. Supply disruptions and inventory levels also play a significant role in propane price dynamics.

To demonstrate the potential diversification advantages of incorporating these commodities, the correlation table below showcases historical relationships between these markets, the BCOM and S&P 500 Index. As the table shows, the correlation of these futures with BCOM (representing a diversified commodity exposure) and the S&P 500 is very low across the board.

How accessible are these commodities? Understanding market accessibility and liquidity is crucial for investors. The table below provides average daily volume (ADV) and open interest (OI), both in number of contracts and notional USD value. Notional value refers to the total dollar value of trading activity based on the prevalent price of the commodity. The table also indicates the primary trading method for each contract (screen-based or OTC block).

While broad commodity indices (also listed as CME Group futures) offer a solid foundation for portfolio diversification, investors can also choose to look beyond these benchmarks. By incorporating smaller commodity markets, investors can refine their diversification strategies, potentially mitigating portfolio risk and improving overall performance further. These commodity products offer unique exposure to idiosyncratic supply/demand dynamics and can play a valuable role in portfolio diversification efforts.

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Originally Posted on May 21, 2025 – Beyond the Benchmarks: Exploring Diversification Within Commodity Markets

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.