Question on Commodity prices Business, directly, general, backing, returns

canadiananalyst

R36, Pg. 54, V5: Under special risk characteristics, 1) Business cycle-related supply and demand.
3 points are given why commodity returns have been weakly correlated with stock and bond returns.
Point No.1 - Agree with it
Point No.2 - Ok. If you say so, can’t argue without any backing, but ok, that’s the general characteristic of a commodity
Point No.3 - Commodity prices tend to decline during times of a weak economy. Doesn’t this directly contradict the second point? Bond and Stock prices also decline during times of a weak economy. So how are they weakly correlated??
Thx

Mechanic

Thanks for that. I guess the key words would be “low correlation” as opposed to “negative correlation”.

thisisbrianly

sparty419,
I wish I can tell u whether there is a direct contradiction or not, but here’s my take:
–Generally CFA materials try to state that alternative investment (including commodity) is a good diversification tool to the typical investment (stock & bond) in a broad sense because their return/risk are “weakly correlated”.
–There are lots of flexibilities in the whole thing. First, stock and bond returnes may not correlate with each other. e.g. In a downturn, stocks perform poorly. However, fixed-rate bonds in your portfolio may perform well since the Fed continually cuts interest rate. Unless there is a credit crisis, most avg. and high quality bonds should do good in a downturn. This is probably the thing that threw you off because CFAI wraps the 2 separate asset classes as one here.
–Commodity price are highly correlated with inflation. However, stocks performs well with low/moderate inflation but poorly in high inflation.
–Correlation is a matter of “degree” in some circumstance. Zero and negative correlations are good for diversification. In addition, “low/weak” correlation can be used for diversification as well. In a upturn, commodity price usually goes up so does the equity price, but it may not be in a highly correlated way in every instance.
CFAI just tries to say that commodity can be a good diversification tool for everyone’s portfolio usually containing a mix of stocks and bonds. If I got anything wrong, please let me know.

lc26mizzou

Anyone again???

TheMBAGlover

1) Commodities correlate positively with inflation whereas stocks and bonds are -vely correlated with inflation
2) Commodity prices and stock/bond prices react differently in different phases of the business cycle. Commodity future prices are more affected by short-term expectations, whereas stocks/bonds prices are affected by long-term expectations.
3) As mentioned above.

tarik64

Can you post what the 3 points are