Proponents of commodity investing typically point to the overall low correlation between commodities and other asset classes as one of the three main benefits of commodity investing (the other two being equitylike returns and a positive correlation with inflation).1 Over the last 50 years, the stock-commodity and stock-bond correlations have been close to zero. However, these point estimates conceal wide degrees of variation. For instance, the annual correlation between stocks and commodities has ranged from -0.39 to 0.76.2
As has been widely noted, the recent stock-commodity correlation has been at the upper end of its historic range. Less widely discussed, the bond-commodity correlation has been at the lower end of its historic range. This situation has led some to wonder whether the relationship between stock and commodity returns has permanently changed, with some suggesting that increased investor interest has led to a higher correlation between stocks and commodities.
In this article, we explore the evolution of the stock-commodity and bond-commodity correlations. We also explore the evolution of the correlation of commodities to each other. In particular, we are interested in whether these correlations have changed over time and whether variation in the correlations is affected by underlying economic conditions.
We find that the stock-commodity correlation and the intra-commodity correlation have a business cycle component; i.e., these correlations increase during the periods of economic distress. However, the bond-commodity correlation does not display a similar relationship. All three correlations are highly persistent, meaning that shocks to these correlations last a long time, some longer than others. For instance, one-standard-deviation shocks to stock-commodity and bond-commodity correlations have half-lives of 9.3 and 6.9 months, respectively, while shocks to intra-commodity correlation have half-lives of 20.8 months.3
Data And Summary Statistics
The commodities we study are those contained in either the Dow Jones-UBS Commodity Index or the S&P GSCI (the former Goldman Sachs Commodity Index), omitting duplicates (e.g., we include WTI crude oil, but not Brent crude oil), and including tin, platinum and soybean meal, based on the subjective assessment that they are important economically, have liquid futures markets and are of interest to investors.4 We construct (excess) investment returns for futures by taking a long position at the end of each week in the nearest-to-expiry future that does not have its first notice date or expiration date in the next month. We construct an equal-weighted index, and from this, construct weekly returns.
For the stock-commodity correlation, we compute realized correlations between weekly stock5 and commodity returns. We use the same method for the bond-commodity correlation. Weekly bond returns are based on 10-year Treasury yields available from the Federal Reserve. Total returns are computed assuming the bond has 10 years to maturity, the coupon is equal to the initial yield and interest is compounded semiannually. For the average intra-commodity correlation, we take the average of the realized correlations of all the commodity pairs measured over annual horizons. For simplicity, we sometimes refer to this as the intra-commodity correlation.