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Guest Post: Correlation Between Commodities And The S&P
Submitted by Sehm Adrangi and John Borack of Kerrisdale Capital
Correlation Between Commodities and the S&P
Bloomberg recently reported on the increased correlation between the
CRY commodity index and the S&P, claiming that increased
correlation decreases the incentive for investors to be in commodities
and that continued high correlation will lead to outflows from
commodity funds. But one thing we noticed is that the charts look
completely different depending on how far apart the data points are
spaced. Below we provide charts with data points taken monthly,
quarterly, and annually.
Monthly:
Quarterly:
Annual:
There are a few things to note.
First, the correlation results are highly dependent on whether our
time periods are monthly, quarterly or annual. If we look at the period
from 1996 to 2003, the monthly data shows a distinctly positive
correlation for most of the periods, whereas the quarterly data shows a
negative correlation for most of the periods. This inconsistency makes
these charts somewhat unreliable.
Second, the historical data shows little indication that the current
positive correlation between stock prices and commodity prices will
continue. Over the past thirty years, the correlation stats have
bounced around sufficiently randomly that it’s difficult to draw any
predictive trends.
All of that said, the current correlation between stock prices and
commodity prices is unusually high. Commodity fund managers who have
become accustomed over the past few years to marketing their products
for the diversification benefits will be in trouble if the correlation
between stock prices and commodity prices doesn’t revert, even if
there's no reason to believe the trend will continue.
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Interesting, but confusing as to what it means. Maybe it just shows that in 2010 the manipulation in both asset classes has become acute (and clumsy).
since the mid 90's and more so after 2000, the global markets have become much more correlated than in the past due to the liquidity component...so as global liquidity ebbs and flows, so do the global markets...it has nothing to do with the time intervals you look at, just the time frame!
Correlation are like the wind. Never too predictable, always watched by the sailor who want to keep his sheets taut.
Algorithmic trading will always ruin correlations because they rely so heavily on them in their decision matrix and therefore will trade them in order to influence them.
Yes, but it's a negative correlation between commodities and equities that many HFT's look to exploit. That inverse relationship exists because as the price of commodities goes higher it eats into the margin and earnings power of most companies that use those commodities as their inputs. If correlation is on the rise, it's in spite of the HFT's, not because of them.
" the current correlation between stock prices and commodity prices is unusually high."
Sure, we are mostly trading bets on QE and inflation/deflation expectations.
yup... like supply and demand are driving them lol... baltic dry
look at a monthly of gold
250 to 1250
I think the correlation in behavior between, say, SPX and GLD is actually pretty strong because the markets are controlled in a similar fashion, though it's worth noting that GLD's downward spike was not nearly as large because, even at 100+:1 ratios, it's still tied to something of value.
ETF's
+1
Won't be long before we see an ETF of ETFs ala Hedge "fund of funds"
Ha, +2.
And just like with the CDO squared, that will be the bubble signal and the time to exit.
The markets are now binomial - risk on/risk off, PD liquidity from FED is the driver.
cry is a spot
index and what matters when you are rolling commodity futures is the index of
the rolled futures contracts. These are very different because of
backwardation/contago fluctuations and
are a big deal in commodities. That is, a short run oil price spike is
smaller 1 year out on the forward curve. So correlations using spot prices
tend to be more correlated with stocks than correlations with
commodities futures indexes like GSCI. Assume much lower than indicated here.
Couple of reasons things happening here.
1a. This is a true macro traders environment. I believe at 1 point we had for 2010 Copenhagen exchange +20%, Madrid exchange -20% (roughly). Countries, FX and economies matter.
1b. This is a true macro traders environment. Inflation/deflation is the only game in town, to which commodities/equities react mostly the same, and equities do so via the indices not via each stock.
2. This is a fucked up liquidity situation. Money matters, above all else. All assets move together as funds need to realise cash or get invested again.
3. Sector ETFs increasingly dominate stocks. All stocks in a sector tend to move together more than ever. For example, given an ETF option, and each equity option, you can back out a rough 'implied correlation' for that sector. Sometimes that is now trading over 100%.
So I'd expect to revert to lower correlations when we solve the liquidity problems in Europe, when its political problems are also fixed, when inflation is safely under control, and when the ETF market dies. Until then, moves in breadth ($TRIN, anyone?) will be extreme, as Tyler posted a while back. Hum, don't hold your breath.
Let me explain some math:
"Correlation" is a statistical-probability tool from mathematic - to prove or reject some HYPOTHESIS about the cause-event connection, about "what cause drives this event".
Hypothesis is a proposed explanation for an observable phenomenon.
There is no "correlation" in above observed events, because there is no hypotethis about "what drives what". Without the hypothesis - the "correlation", calculated by the math manual, MEANS NOTHING.