Commodities Outperform During Equity Market Downturns

Mar. 16, 2007 4:00 PM ETQQQ, SPY, DBC, GSG1 Comment
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Editor's Note: Nik Bienkowski is head of listings and research for ETF Securities, which markets commodity exchange-traded funds (ETFs), primarily in Europe.

I read with interest the article posted last week on (Creeping Correlations, by David Krein). It sparked a pair of important questions for me:

(i) Are correlations really rising with previously uncorrelated assets; and

(ii) If so, does this increased correlation hold during market downturns, when an investor relies on the low correlation of other asset classes?

My queries of the article’s conclusions were justified: The results of my sample do not support the view that the correlation between equities and commodities is rising. In fact, sampling various periods showed that commodities not only have maintained their low correlation, but they also maintained the lowest correlation among the indexes analyzed. Further, when equity markets performed poorly, commodities performed the best relative to the other asset classes, while the correlation between equities and commodities remained the lowest.

Correlations With Commodities Still Remained Low

Factors that affect short-term versus long-term returns

Whilst it is possible that correlations may rise over the short-term – for example, commodity market and equity market returns have both been strong over the last 18 months or so -- the correlation should not rise over the longer term if the asset classes really are driven by different factors. It is not hard to make a case why commodities should be uncorrelated to equities, as commodities are affected by many different factors including exploration success, technological advances, supply-demand (and the time lags to respond to supply/demand changes), the weather, and the depletion of finite resources.

Short-term or long-term correlations?

Index investors, specifically passive investors, when forming portfolios of uncorrelated assets, are generally making a call about the long-term fundamentals of an asset class relative to others. Therefore, whilst it is important to understand the dynamics of non-static correlations, it is important to consider past and future expectations for correlations over a time period that is consistent with the investor’s goals. Unless the investor is active and trading frequently (where even positive short-term correlations may be viewed as good), then low-to-negative correlations need to be viewed with a medium- to long-term horizon.

Commodities have maintained their low correlation

When looking at variations in correlation, the best way to view potential shifts in correlation is by looking at rolling correlation charts, rather than examining tabular results that could be affected by the time period chosen.

The charts below examine the 2- and 5-year rolling correlations of various indexes with the S&P 500, including foreign stocks, hedge funds and commodities. They show that:

· correlations are more volatile over shorter periods;

· in each case, the correlation between commodities and equities was the lowest of any group studied;

· the correlation between commodities and equities has consistently remained low, between 0.0 and 0.2; and

· the correlations between equity indexes has risen over time.

Note that these results do not show that the correlation of asset classes with lowest correlation increased the most over the past five years.

bien 2 yr

bien 5 yr

Commodities Outperform During Equity Market Downturns

The charts above show that commodities have maintained their low correlation with equities – the lowest of the commonly studied asset classes. For the investor, however, this is almost an irrelevant statistic if, during market downturns, the asset classes are positively correlated. After all, that’s when we want noncorrelated assets to do their work. The worst case would be to hold an asset that had a negative correlation when equities were performing well, and a positive correlation when equities were performing poorly – such an asset class would always be falling (it would be great for a quick, “short” trade, of course).

The question then is: how have commodities performed during market downturns?

The chart below examines the correlations of a variety of indexes, including the Dow Jones-AIG Commodity Index (Total Return), during three time periods: market downturns; the 10 worst months for the S&P 500; and the 20 worst months for the S&P 500.

The other chart examines the absolute performance of the various indexes during difficult market times. Note that the DJ-AIGTR was the only index to provide positive returns during down months for the S&P 500.

Taken together, the two charts show:

  • commodities maintained their low correlation during equity market downturns;
  • commodities outperformed during periods of equity market underperformance; and
  • other equity market indexes showed little diversification benefit.
  • bien correlation 1

    bien correlation 2
    (The data covers the period from 12/31/1993 through 2/28/2007)


    Investors should always be aware of changing investment fundamentals and statistics. However, keep two things in mind: (i) commodities have performed well over the past 5 years; and, (ii) correlations between commodities and equities remain low due to the different factors which affect returns; and, (iii) commodities have performed well when investors were relying on their diversification benefit.


    The correlation matrices below show correlations for three different 3-year time periods, showing once again that, while correlations vary over periods, the correlation with commodities remains low (and is possibly one of the lowest) against U.S. equities.


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