I thought commodities were uncorrelated with equities?

The sell-off in equities has also seen a sell-off in a number of commodity markets. This performance is not surprising when you look at the specific markets which have moved with equities. These moves should not be associated with contagion from the credit crisis or at least not directly. There is spillover between equities and commodities associated with changes in economic growth expectations.

Commodities are uncorrelated with equities over the long-run as measured by daily or monthly returns. The correlation for major commodity is close to zero, but the performance of the index is not the same as individual markets, so any comments concerning commodities have to be tempered by the specific market discussed. The correlation between these asset classes also have to be compared at different times in the business cycle to fully understand their relationship.

Crude oil has sold off with equity markets; however, over the long-run the correlation with equities is low. Over the long-run, crude oil price increases have usually preceded a recession. Hence, the oil price rise without a recession over the last few years is what has been unusual. Currently, the decline in growth prospects has hit the equity markets and has also caused sell-off in oil. The high correlation is coincident with a business cycle downturn. Base metals are also pro-cyclical, higher growth expectations lead to rising prices. Again, the lower expectations for US growth has reversed prices in industrial metals like copper. Nevertheless, the relationship across the business cycle is not the same for commodities and equities. Commodities will see their price rise closer to the end of the cycle.

However, many commodity markets are not correlated with equity returns. Specifically, the grain and soft markets have moved in different directions. Soybeans and wheat are hitting multi-year highs. These are all markets which have higher short-term correlation with weather behavior.

Commodities are uncorrelated, but there are common factors which can make them correlated during specific periods. A common business cycle shock is one of those factors. This common factor has been driving short-term behavior.