Oil and other commodities typically lag more mainstream assets, making them attractive as investment portfolio diversifiers, but since January, they have been swept up in the volatility gripping nervous equity markets.
The correlation between US crude and US equities has been 82 percent, compared with 37 percent the previous year and -63 percent in 2006, according to figures from Standard Life covering the start of the year to this week. For North Sea Brent crude and British equities, the link has been even tighter at 88 percent, compared with 7 percent last year and -37 percent in 2006.
The new-found - and probably short-lived - closeness can be explained at least in part by liquidation and profit-taking in energy markets to help to offset losses in equities and other assets that have headed lower in response to fears of recession.
"At times oil and equities can briefly track each other for a variety of reasons ... but there is nothing stable in that relationship," said Antoine Halff of Newedge brokerage.
The economic worries that have driven selling on stock markets are also bearish for oil markets as economic slowdown would reduce demand, but traditionally oil markets react at a different pace from equities. "Equities discount growth fluctuations upfront. Commodities do it when it actually happens .... Equities will fall first going into recession and recover first," said Tim Bond of Barclays Capital.
Negative correlation, or commodities and equities behaving differently, is useful for long-term investors, who want balanced portfolios. But for some speculators on the oil markets, the stock market sell-off has provided much-needed direction. "The oil market has been in a relatively quiet period with no major winter threats, no major supply disruptions and the higher volatility in equities has become a directional input for oil markets that were lacking a clear driver," said Olivier Jakob of Petromatrix.
He traced the link between oil and equities back to January 17, when the Dow Jones Industrial Average broke a major support line and he too predicted the correlation would be temporary.
Technical traders can run an algorythmic model that trades oil according to equity indexes when the correlation becomes high. "This will work as long as the two markets trade on the same fear factor, but will break down as soon as the core fundamentals start to price back in," Jakob said.
Fundamentals of supply and demand for oil and other commodities remain strong and are likely to do so for as long as economic growth fears are focused on the United States and Europe.
These regions have accounted for a small proportion of incremental demand compared with the expanding Chinese market. "Chinese growth estimates have slipped a couple of points. If they slip another couple of percentage points, we'd have a more convincing case for commodities coming off," said Bond. The growth of consumption in China and elsewhere in Asia has tightened supplies to the extent that commodities in general look more resilient than they have during previous economic slowdowns.
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