The Business Insider delineated 14 possible crises that could shake up the markets if they occurred. All 14 are “headline grabbers” and the talk of Twitter, but there is one that went unnoticed and I haven’t seen it mentioned on the WWW: correlation risk between equities and long-only commodities.
All you need is one unsuspected event in the US – forget the 14 in the article – and you’ll see your portfolio lose more than you might realize.
Stocks are leading the Bull markets, while commodities are following, as stocks are forecasting positive GDP growth. Moreover, there is more available capital to buy stocks than to buy
commodities, so this has also helped stocks outperform commodities recently. Thereby, commodities have been in a long trading range (in aggregate) from June 2009 to date, only creeping up.
However, amazingly the long-only commodity universe has had a tremendous positive correlation with stocks since January 2008; the S&P 500 has a 97.92% and 98.32% correlation to the DJUBS and the S&P GSCI (Long Only) Commodity Indexes, respectively.
Interestingly, the appreciation of these commodity indexes as represented by their ETNs (DJP and GSP was +25.5% and +37.1%, respectively, from March 2009 through the end of March
2010, while the S&P 500 has rallied 72.86% during such time period.
Due to the highest correlation I have ever seen between two different asset classes (even Long- Term U.S. Government Bonds have only a 93.9% historical correlation to Intermediate-Term Government Notes), if growth is lower than expected (3%-4%) both commodities and stocks should decline.
Source: EAM Partners, LP
That means you’re not going to see any diversification benefits in the short-term if the S&P goes south and you are a long-only investor. Worse, because the correlation to equities is so high, you’re going to lose on your long-only commodity investment(s) at the same time, making the % hit to your portfolio much greater than you may be expecting.