When analysing analysts' opinions, we often come across statements about the dependence of commodity prices on the dollar or the negative impact of bond yields on the stock market. Sometimes these are overused, without being supported by concrete research. In order to better understand the current market situation, we have therefore decided to carefully analyse the data of the last 10 years in order to identify which asset classes are most closely linked. We will also try to explain what impact this may have on the current situation?
A few words about correlation
A correlation in the investment world is a relationship (between two or more variables) defining, mutual dependence. Correlation indicates not only the strength, but also the direction of the relationship between, for example, two financial asset variables. For the purpose of the analysis, let us assume the following asset classes: equities, bonds, currencies, commodities (including precious metals), cryptocurrencies and real estate.
Correlation between assets can be positive, negative or neutral on a scale of -1 to 1. Positive correlation means that two variables move in the same direction, e.g. an increase in one asset results in an increase in the other. A negative correlation means that two variables move in opposite directions, e.g. an increase in one asset results in a decrease in the other. No correlation means that changes in one variable do not affect the other variable.
Correlation is an important tool for investment risk analysis as it allows investors to diversify their investment portfolio. By selecting assets with different correlations, investors can reduce investment risk and increase the chances of achieving potential returns with lower risk. The table below shows the results of the analysis.
Source: Correlation table, own study
Equity market heavily dependent on each other and more...
The first asset class we will look at is the equity market. The highest correlation of up to 0.95 occurred between the S&P 500 index (US500) and the US Nasdaq index of technology companies (US100). A high correlation (of 0.57 and 0.51) also occurred between these indices and the German DAX (DE40) index. The least correlated between stocks was the Nasdaq index against the Japanese Nikkei index (JP225).
The correlation between the S&P 500 and the Vanguard Real Estate Index Fund was particularly high (0.75), implying that changes in the stock market may affect US real estate prices. Therefore, it is plausible to assume that increases on the S&P 500 may result in higher prices quoted on real estate investment trusts, such as the iShares Residential and Multisector Real Estate ETF (REZ).
Interestingly, two types of investments had the highest negative correlation with the S&P 500 index: bonds (correlation minus 0.28) and the US dollar-Canadian dollar currency pair (correlation minus 0.21).
Source: Contoxia MT5, REZ, Daily
The foreign exchange market and its relationships
The most correlated currency pairs were the New Zealand dollar (NZD/USD) with the Australian dollar (AUD/USD), where the correlation was as high as 0.82. The second most correlated currency pairs were the Canadian dollar (USD/CAD) with the Australian dollar (AUD/USD) (correlation minus 0.68).
The highest correlation between the main euro/US dollar pair (EUR/USD), we can find for the dollar/ Swiss franc pair (USD/CHF) (correlation minus 0.6).
Currencies seem to be rather moderately correlated with other asset classes. Nevertheless, there is a negative observable correlation between the US dollar index and precious metals. The highest correlation is seen between the US dollar index and gold prices, where the correlation is minus 0.4. This means that when the US dollar weakens, gold prices can be expected to rise with medium probability. The current rises in gold prices above US$2,000 seem to reflect this situation well. An increase in the level of the economic downturn and the banking crisis in the United States may contribute to a further weakening of the US dollar, which could positively influence gold price increases in the medium term.
Source: Conotoxia MT5, XAUUSD, Daily
Commodities and precious metals
As expected, we can find the highest correlation (correlation of 0.79) between silver and gold quotations. This may be due to their widespread use in jewellery, but also according to history, precious metals worked well as a substitute for fiat currency. It is worth noting here the high correlation of platinum and silver (correlation 0.65), which is higher than that with gold.
The theory of gold's role as an investment safe haven seems only partially justified. While gold's correlation with the S&P 500 index of almost 0 may indeed protect us from potential declines in equities, it may not translate into returns over the long term. The situation is similar for gold and long-term bonds (e.g. the iShares 20 Plus Year Treasury Bond ETF), where the correlation is 0.25. This means that sooner gold could be linked to changes in bonds, which are also considered a so-called safe haven, than to the possibility of earning from potential drops in indices.
Source: Conotoxia MT5, TLT, Daily
Grzegorz Dróżdż, CAI, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73.18% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Trade this news from Conotoxia Ltd. platforms
Go to your account
