As the old saying goes-water, water everywhere and not a drop to drink. The same could be about the information in futures prices-notably oil futures; the information is everywhere, easy to access, but not so easy to interpret. However, it is indubitable that if any futures prices were to be considered a leading indicator for other commodity futures, it would be oil futures. The correlation between oil futures and commodity futures can be explained in a variety of ways-most notably the relation between economic growth, the demand for oil by emerging economies and the concomitant demand for other commodities fueled by this growth. The instantaneous correlation between oil futures and other commodity futures can be linked to supply shocks that would affect both markets, but what's less apparent is whether oil futures today are lead indicators of futures prices some months in the future, as shocks to oil prices work themselves into the production process over time.
So I decided to look at correlations between oil futures today (notably the benchmark Brent crude futures price) and lead futures for other representative commodities and found some interesting trends. Some explanations for these trends are obvious, others less so. It should be noted that the analysis below is predicated on "normal" seasonality trends or non-catastrophic relations between oil futures and futures of other commodities. In other words we are abstracting from the effect of wars, abnormal supply shocks, natural disasters or other "black swan" events.
We examine correlation between oil futures on the one hand, and one month ahead, two month ahead, four month ahead and six month ahead correlations with other representative commodity futures. We look at futures prices over the last year and a half, and roll the futures contracts over to the next contract on the seventh of the expiration month.
Oil and soybean futures.
It's well known that correlation does not imply causality. There may be common trends driving two markets together causing the correlation. Conversely, lack of correlation may just mean a supply shock adversely affecting one market and not another when "normal" relations would indicate a close causality between the two markets. The correlation between soybean and oil futures shows a positive spike at .48 when current oil futures are correlated with four month ahead soybean futures, with little relation for other leads. It seems that we're seeing the effect of oil as an input in soybean production in this close correlation between current oil futures and 4 month ahead soybean futures.
Source: www. quandl.com
Oil and coffee futures
Next we look at the relation between oil futures as a lead indicator of a "soft" commodity such as coffee. Here, the highest correlation of .47 is between the current oil and coffee futures. Probably this tight contemporaneous correlation is indicative of general sentiment with regards to commodities in general, coffee and oil being considered commodities. The high contemporaneous co-movement between coffee and oil has already been noted-"coffee and oil are like sisters".
Oil an important component of Dow Jones commodity index futures
The relation between Brent crude futures and the Dow Jones commodity index futures is much simpler to analyze. There is a very high contemporaneous correlation between Brent crude and the Dow Jones-UBSCI commodity futures-namely .57 (maximum is 1). There's no mystery here-the 2012 weighting of Brent crude in the 2012 index composition is 5.32%, the third largest component after natural gas and WTI crude. Interestingly, after subsequent leads indicate negative correlation, 6 month ahead DJ-UBSCI returns to a positive, albeit lower correlation, i.e. -.28.
The tight fit between oil and contemporaneous gold futures
Oil and gold futures have a very high contemporaneous correlation, i.e., .49. This, again, like with coffee futures can be explained by the underlying dependence on inflation of both types of futures, as well as general trends in commodities that impact both commodities in the same way and simultaneously.
A tale of inflation, the dollar, oil and 10 year yields.
The curiosity in this data is the relation between Brent crude futures and 10 year futures notes. With a contemporaneous correlation of almost zero, we see the highest correlation between current oil futures and 2 month ahead 10 year futures notes, at .4, dipping again into negative territory and then increasing again to .3 for the 6 month ahead 10 year Treasury notes correlation with current oil futures..
The reason for this zero contemporaneous correlation is probably because of the inflationary impact on both oil and ten year notes, working themselves into the two variables with a lag. As well, a weak dollar increases both oil prices and inflation, eventually working itself into 10 year yields, 2 months and 6 months ahead.
When oil goes up, the S&P goes down.
Finally there is a consistent negative correlation between Brent crude futures and the S&P 500 at all leads, as well as contemporaneously. What's bullish for one is bearish for the other. Again, inflation is probably to blame, since inflation reduces corporate profits, while increasing oil prices. However, the correlation between Brent crude futures and S&P 500 futures is almost zero with the 4 month ahead lead, the highest correlation level calculated between these two futures prices, the other leads being strictly negative.
Oil the best predictor of future agricultural commodities?
If predictability is the criterion, it seems that the current Brent crude futures can best be used to predict agricultural commodities 4 months ahead, if soybean futures are any indication. Short of that, inflation and monetary policy seem to be the driving factor determining both oil futures and other commodity futures. Other "invisible" factors also probably play a prominent role-Brent crude oil futures are no crystal ball into future trends for these other commodity based futures.