ARE COMMODITIES FINALLY DECOUPLING FROM THE STOCK MARKET?
August 23, 2010
We have talked quite a few times in this space about the poor 2009 conditions which left many managed futures programs with losses last year (read:
“2010 Managed Futures Outlook”
), and even how some of those conditions carried through to the first quarter of 2010 (read:
“ Are Managed Futures done with the poor 2009 conditions yet?”
).One of the main reasons for the poor performance, we contend, was the abnormally high correlation (coupling) between commodity markets and stock prices, andbetween commodities themselves. Everything became one big Global Recovery/Recession trade (read:
“ The Global Recovery/Recession Trade ”
) – with markets adiverse as Cotton, Crude Oil, Gold, and Russell 2000 futures essentially becoming one big “market” which rose when traders believed we were headed for arecovery in world economies, and fell when it seems there’s more global recession ahead.With some big moves up in commodities like Wheat and Coffee over the past few months while equity prices have fallen (both are up around 25% while the S&Phas fallen -11% since the end of April), it is starting to look like stocks and commodities may be coming less correlated, or to borrow a term from economists:‘decoupling’.It may be happening just in time. With nearly three quarters of 2010 behind us and the managed futures indices remaining below their early 2009 highs, the soonerthis pattern ends and we return to an environment where markets start to trade on their own accord based on supply and demand fundamentals, the better as far amost managed futures managers are concerned.
One big “market”?
Stocks and commodities are supposed to move independently of each other, because they are valued on entirely different premises. Commodities provideeconomic value through being consumed (Sugar in your coffee) or transformed (Crude Oil into Energy), while the value of stocks and bonds lies in the value of theifuture cash flows.Because commodity markets move in reaction to global supply and demand, not the future cash flow of corporations, they are not supposed to be at risk from stocprice declines, liquidity issues, and credit problems which until 2008/2009, nobody understood closely tie together hedge funds, stock, bond, and real estateinvestors.But the credit crisis threw this concept of commodities having little to no correlation with the stock market on its head. That simply wasn’t the case throughout thelast quarter of 2008, most of 2009, and into the first quarter of 2010.Consider the table below which shows the daily correlation between each of the listed markets and the S&P 500 stock index over the listed time frames (1mo, 3mo1yr, 5yrs, and 10yrs). In each market listed, the daily correlation over the past 5 years is higher than over the past 10 years. And the past year is higher than the 5year reading – which all points to steadily climbing correlations.As a refresher, correlation is a statistical figure with values which range between -1.00 and +1.00, meant to show how inter-related two sets of data (in this casemonthly % returns) are. If they have a correlation of 1.00, they are perfectly correlated, meaning when one market rises 1%, the other will do the exact same, andwhen one loses -1%, so will the other. If they are at -1.00, they are exactly opposite; with one making the exact opposite amount the other loses each day, and vicversa. We wondered in a past newsletter if this is a structural shift (a new paradigm) in how stock and commodity markets interact with one another, perhaps based onenergy companies becoming so large that they are a large percentage of the stock indices or something to do with investors adding commodity ETFs to theirportfolios – and at first glance it appears that the trend is continuing.But when we add the past 3 months and past 1 month daily correlations to the table, we start to see a lot more green (negative correlation), painting a differentstory.