Friday, April 08, 2011

Oil Correlations

We are all intrigued with the way the stock market has been increasingly tracking the crude oil price movements.
But there are some startling facts when we take a closer look at the numbers behind the story.

For my analysis, I looked OIL (iPath S&P GSCI Crude Oil TR Index ETN), which tracks the Goldman Sachs Crude Oil Return index which is composed of WTI crude oil futures contracts traded on NYME.

Now if we compare the correlation based on yearly returns on this ETN and the 3 major US based Indices we notice a gradual increase of correlation for the last 4 years, from 2007 to 2010.
Yearly S&P 500 Dow Nasdaq
2010 72.25% 70.09% 67.83%
2009 56.43% 54.32% 51.41%
2008 39.58% 36.58% 34.97%
2007 10.26% 6.90% 6.47%

But what will be startling is the correlation of YTD returns for the same combinations as above and also compare it for the last 5 years for the same time period (first 68 trading days).
YTD S&P 500 Dow Nasdaq
2011 -19.46% -18.61% -23.74%
2010 63.96% 62.81% 54.80%
2009 47.86% 44.92% 43.53%
2008 60.71% 59.49% 58.58%
2007 9.55% 7.35% 4.86%

2011 shows us that the equity markets are negatively correlated to the crude oil prices but instead of a behavioral change in relationship, I would attribute it to the systemic pressures on the market such as the Mid-Eastern political upheavals, Japanese nuclear meltdown and the Capital Hill crisis.

2 comments:

Maverick said...

Hmm....you have considered years which do not ideally give you the correlation between crude prices and stock indexes..... indexes are increasing after recession and hence you see a positive correlation.....ideally there should be a negative correlation if some more macro economic factors come in.... higher crude prices sucks liquidity and hence has a negative effect on markets....2011 you have seen a negative correlation since crude has increased drastically with Middle-east crisis..

Arindam said...

the impact of higher crude prices on the bottom line of corporations is common knowledge to the layman and your point about the negative correlation in 2011 has already been addressed in the article.
In fact I would advise you to look at a chart in this article - http://tickersense.typepad.com/ticker_sense/2007/12/sp-500-correlat.html
The higher correlation is due to the way the indices are constituted especially the S&P 500 which is market-weighted hence the run up seen by crude oil impacts the index proportionally.