September 08, 2009
Posted by: Laurence Hayward
The relationship between currencies, commodities and stocks is
a moving target. Since August 24 there has been a very tight
correlation between the Shanghai Composite Stock Index and the
Commodity Research Bureau (CRB) Index. For once there can be little
discussion as to which is leading and which is following. With
China consuming so many commodities, the CRB Index is affected if
there are signs the Chinese economy is slowing; it declines when
Shanghai stocks decline as the presumption is that demand for
commodities will slow down.
The interesting point from the currencies perspective is that oil
is not so closely linked as the composite index of all commodities.
This brings me to another point I have often written about: the
correlation between the dollar and oil. In my last commentary I
pointed out that this tight correlation was disconnecting due to
speculators partially withdrawing from the market. This
relationship is a common occurrence in the market, especially in
the past two years. As investors mature in the asset class they
fine-tune their focus in an effort to be one step ahead of the
market and make more money.
Where investors/speculators used to trade the CRB Index in the same
way you could trade a Dow index fund, they now trade oil or metals
and precious metals and soft (agricultural) commodities because
these components often move in different directions on the same
day's trading. The CRB Index is not an efficient method to maximize
profits. Just as the Dow is a market of individual stocks making up
a stock market, the CRB Index is a market of commodities making up
a commodity market. Of course, participants in these markets have
been trading soy beans, lumber, gold and oil individually for
years, normally hedging their natural business. However, what has
changed is the influence and the massive jump in the amount of
business in these component markets that is driven by
investor/speculator participants. This has come about as the
financial crisis led these participants to seek out other asset
classes as investments after credit and stock markets became so
uncertain. This new participation led to last year's run up in oil
as the largest speculators came to the realization they could
almost control the market in the same way the Hunt brothers tried
but failed to corner the silver market in 1979. The big difference
was that in 1979 they did not have the interconnected global
financial markets of today.
To get back on the subject, Monday showed just how disconnected the
oil-dollar relationship has become. Oil fell $3.40 per barrel,
while the euro rose one cent and the pound rose nearly one and a
half cents. In the height of last year's speculation, the currency
to oil correlation was so close it could be defined that a $5 rise
in oil was equal to a 1 cent rise in the euro. The reason turned
out to be that the speculators bought oil in an effort to make more
money by also buying the euro. The market believed in the idea of a
relationship and it became a self-fulfilling prophecy, just as when
a prominent technical analyst calls the top or bottom of a market
and everyone follows his observation by either selling or buying
and the prediction becomes true.
The relationship between oil and the dollar has returned to what it
should be: a directional relationship over a longer period of time,
not a second-by-second link between the two. A weaker dollar means
higher commodity prices. If we use the euro as an example, then in
euro price terms the price should be similar, so the price of gold
in euros in this scenario does not change as much as the dollar
gold price changes. The reason the dollar is weakening versus the
euro is normally fundamental - either worse economic news for
the U.S or better news for Europe.
This has led us to a position where the energy traders are looking
for something else to correlate with oil now that the speculators
have dissipated, and they have found the Dow.
You may ask how this knowledge helps you determine what the
currencies are going to do. The answer is another step in the chain
of reactions. When the Dow goes up, oil follows it and because oil
has gone higher (notwithstanding other influences such as
fundamental economic news), currencies should strengthen. Where
this does not make sense is that if stocks rally, normally bonds
would be sold off. If bonds are sold, interest rates rise which
would normally attract funds to the dollar. How do I explain this
away? It's simply a matter of knee jerk reaction compared to a
longer time frame. As interest rates typically move more slowly
than the other markets, they normally do not create a
minute-by-minute reaction unless their move is huge. However, the
other markets and the dollar will be swayed by higher rates if they
are sustained over a longer period in time, reversing the reaction
that occurred on the short term.
I hope I have succeeded in pointing out how the market
interrelationships have changed of late and that it helps you
assess your foreign currency risk by looking at the current reasons
why the markets are reacting the way they are.
Here is the caveat: the above explanation is today's new "normal."
If stocks suffer a global fall out and fear takes over, money will
flow to U.S. bonds exactly as it did a year ago and the dollar will
strengthen as foreigners buy dollars to buy the bonds. In this
scenario oil and commodities just follow the lead and get sold off;
their importance has been diminished by the change in
circumstances. This scenario would be defined as risk aversion. The
opposite a higher risk appetite would follow the scenario described
above with higher stocks commodities and lower dollar and
The following excerpt will be included in your message.
Commodities, Currencies and EquitiesOctober 22, 2012 Posted by: Laurence Hayward
The relationship between currencies, commodities and stocks isa moving target. Since August 24 there has been a very tightcorrelation between the Shanghai Composite Stock Index and theCommodity Research Bureau (CRB) Index. For once there can be littlediscussion as to which is leading and which is following. WithChina consuming so many commodities, the CRB Index is affected ifthere are signs the Chinese economy is slowing; it declines whenShanghai stocks decline as the presumption is that demand forcommodities will slow down.
The interesting point from the currencies perspective is that oilis not so closely linked as the composite index of all commodities.This brings me to another point I have often written about: thecorrelation between the dollar and oil. In my last commentary Ipointed out that this tight correlation was disconnecting due tospeculators partially withdrawing from the market. Thisrelationship is a common occurrence in the market, especially inthe past two years. As investors mature in the asset class theyfine-tune their focus in an effort to be one step ahead of themarket and make more money.
Where investors/speculators used to trade the CRB Index...Read More