Commodities  

The relationship between commodities and traditional assets

This article is part of
Guide to investing in commodities

Post-crisis

But ever since the financial crisis, the relationship between commodities and stocks and bonds has shifted to negative territory, or remained positively low. 

A correlation coefficient of 1 represents a perfect correlation between the movements of two commodities, a coefficient of -1 means two commodities move in opposite direction, while a coefficient of 0 implies no relationship.

Figure 1: The correlation between 13 commodities and the S&P 500 

Source: Teucrium Trading 

Data published in 2018 by Teucrium Trading showing the correlation coefficient between 13 key commodities and the S&P 500 over the past 20 years, shows platinum to have an extremely low correlation of 0.04. 

Meanwhile, other commodities, such as silver, had a higher, albeit low correlation of 0.25, and gold had a correlation coefficient of 0.48. 

Mr Johnson highlights that during periods of expansive monetary policy measures by the Fed (lower interest rates), equities performed very well. Conversely, when Fed policy was restrictive (interest rates were rising), equities performed poorly. 

He says equities had an average performance when the Fed kept rates flat. 

Quantitative easing

Mr Brennan points out: “The threat of rising rates in 2013 caused the correlation between commodities and equities to break down.

"Commodities have always been an evergreen component of a well-diversified portfolio.”

He says the typical correlation between equities and commodities ranges from -0.2 to 0.4.

The financial crisis paved the way for central banks to begin purchasing many government securities – a process known as quantitative easing – in order to lower interest rates and increase money supply.

“During QE, the correlation got as high as 80 per cent, but following the taper tantrum in 2013 the correlation has been coming down and now sits back around 40 to 45 per cent,” notes Mr Brennan. 

The taper tantrum refers to the period when US treasury yields spiked as a result of the Fed’s use of tapering to gradually withdraw their policy of QE. The taper tantrum caused a rapid sell-off in the bond market, significantly increasing bond yields.

Mr Hanley confirms: “Some commodities may have negative correlations, others might have 'low' but positive correlations."

He continues: “Understanding how an investment is correlated and the degree to which that correlation exists, is an important consideration for an investor constructing a diversified portfolio.”

Mr Brennan says: "As we move into the next period – be it quantitative tightening or tweaking perhaps – with interest rates rising due to higher debt and lower growth, and the prospect of inflation the most credible in years, the asset class is resuming its traditional portfolio-diversifying role.”

saloni.sardana@ft.com