Macro and micro trading in commodities

There is a simple tool used in the stock market to determine whether the environment is good for stock pickers or for macro-traders based on the average correlation of stocks within an index.

The average correlation between stocks is measured through time to determine the type of regime for the markets. When the average correlation for set of stocks is high, it can be viewed as a macro-timing environment. All markets are moving together with a common theme or cause. When the average correlation for the same set is low, it can be considered a commodity pickers environment. Markets are moving independently and do not follow a pattern driven by a single factor.

The height of the financial crisis represents the period of maximum macro-trading. The Great Recession caused all markets to decline and for there to be a liquidity crisis. Correlations all moved closer to one. This is typical of crisis periods. More recently, we are seeing a movement back to a commodity picking environment with correlations declining.There is less correlation across markets because the drivers of return are more localized.

It is now time to be a market picker not just a commodity buyer.