Outlook on commodities correlation to other asset classes

Commodities' recent increase in correlation to equities was acknowledged by panelists at the CME Group's Global Commodity Investment Roundtable, who also discussed the cause and explored the outlook at the gathering in New York on Sept. 12.

Doug Hepworth, director of research at Gresham Investment Management, and one of the panelists, said the state of the world is driving higher correlation of commodities and asset classes. He noted most correlation research only looks at the period since the late 1990s, but examining correlations in the early '80s shows a similar spike. Adam Dunsby, partner, SummerHaven Investment Management, commented the spike in correlation is “consistent with a business cycle component of correlations.”

Ilia Bouchouev, managing director, global head of energy derivatives at Koch Supply & Trading, gave several reasons commodities correlation will not go back to historic averages. He said correlations are going up because individuals and institutions that own equities now own commodities and commodities are now included in a risk-on basket. He said overall higher correlations are driven by globalization and not reversible. However, correlations “are not probably going to be as high as they are now but they are not going back to long-term historical averages.”

Adam De Chiara, co-president and portfolio manager, CoreCommodity Management, commented that the unprecedented level of central bank accommodation has had significant impact on correlations. He also noted that “it is exactly in those stress periods when discounted net present value financial assets typically get hammered when you have that unanticipated inflation that … the negative correlation for commodities typically really spikes high.”

Robert McNally, founder and president of The Rapidan Group, said there could be more “correlation breaks” as government policymakers intervene. An example was would be the sudden change in price and correlation of oil if governments released supplies from strategic petroleum reserves.

The best quote of the conference came from Mr. Hepworth. In commenting on the hunt for alpha in the commodity space, he said: “People talk about alpha gathering as though they are walking through a garden … It is not a garden, it is a minefield.”