Think You're Diversified? Crude Oil Has Other Ideas

by: Jeff Malec

Unless you're an investor who wears cowboy boots or dates Russian models - you may think the energy market volatility isn't all that meaningful to your portfolio. What's energy got to do with bank stocks, or Amazon (NASDAQ:AMZN), or solar companies, for instance? Most of us would assume nothing, but the sharp downturn in global stocks to start the year, followed by the rebound in oil and stock prices since the middle of February has some people shaking their heads. It seems we're all more correlated with the oil markets than we might think.

Now, economists can argue whether commodity prices consistently moving downward over the past couple of years are because of oil or because oil prices are an indicator of bigger problems (like a lack of global demand for goods and services); but it's not just commodity prices. We're talking financials as well, with multiple articles making the rounds recently showing how oil is influencing other markets due to extreme volatile behavior (the CME's take), FT, Bloomberg, and CNN). For example, did the Fed hold off raising rates because of oil prices?

We couldn't help but take a look across a few markets and see just where the correlations stand between a host of markets and crude oil on a rolling 30-day basis. And as you might expect, correlations have been on the rise over the past six months in the six markets we looked at.

30-Day Rolling Correlation

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(Disclaimer: Past performance is not necessarily indicative of future results)
Continuous front month contracts

Turns out the Aussie and Canadian Dollars are essentially bets on oil these days. The highest crude oil correlation is the Canadian Dollar at 0.69 (highest at 0.72 back in January), largely thanks to Canada's economy driven by oil prices. Not far behind is the Emini S&P, with a correlation high of .71 in February. On the flipside, the 10-Year Note prices have the lowest correlation, hovering around -0.60, but that could also be looked at as 10-year rates having a positive 0.60 correlation.

Although no matter how correlated some of our most traded US futures markets get to oil prices, it looks like we're still a comfortable distance away from becoming as correlated with oil as the Russian economy, as can be seen in this chart showing just how close this Russian ETF trades closely to crude oil.

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Chart Courtesy: The Traders Journal