Monday, October 17, 2011

Commodities and (a Lack of) Diversification

Over recent years, commodity indices have become increasingly correlated with the U.S. stock market, and today, provide little in the way of diversification.
To illustrate, below is the 3-year monthly correlation between the Goldman Sachs commodity index (ETF GSG) and the S&P 500, from 1970. Note right side of graph.
The Goldman Sachs index is the least diversified of the major commodity indices, but this observation extends to all the majors.
Below I’ve compared the GS index (red) to the CRB, Dow Jones-UBS (ETF DJP), and Deutsche Bank (ETF DBC) indices in blue. Note the similar results.
Of the major asset classes, only corporate bonds, Treasuries and gold (and currencies if you view that as an asset class) provide any level of real diversification to equities in this market.
Asset classes which have in the past exhibited low correlation, including: commodities, international stock indices (developed and emerging markets), and real estate, all continue to see high levels of correlation to U.S. equities.
This hurts strategies that use diversification as a way to reduce portfolio volatility, whether it’s traditional MPT or something more active like Tactical Asset Allocation.
None of this is new information and I’m not the first to highlight it – just something that we as investors need to keep on the radar. Reducing portfolio volatility through diversification continues to become more and more difficult.

No comments:

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.