Rohit likes Aarti, but has no access to her.
Priya wants to be friends with Rohit. Priya looks a bit like Aarti and behaves like her too, at times.
Rohit and Priya become friends.
Is Priya = Aarti?
Can this question be answered with a resounding yes or no?
Of course Priya is not equal to Aarti. Priya is Priya and Aarti is Aarti. Ask Rohit about it during one of Priya’s temper tantrums.
And, at other times, Priya is just like Aarti. At still other times, Priya is as calm as the Pacific Ocean. Even calmer than Aarti. At those times, Rohit feels he is even better off with Priya than he would have been with Aarti.
After this short diversion into human relationships, let’s study the correlation between commodities and commodity equity.
The average working individual does not have access to commodities as an asset class. He or she is not a farmer, and doesn’t have the time or the nerve to play futures and options, in an effort to put some money in commodities.
Is there any avenue such a person can access, to invest a piece of his or her pie in commodities.
It’s time to study the world of commodity equity.
For example, we are talking about agriculture stocks, precious and non-precious metal mining stocks, oil and natural gas stocks etc. etc.
Do such stocks always behave as their underlying commodity?
Can one put one’s money in commodity equity, and then feel as if one has put the money in commodities?
These questions can be answered in terms of correlation.
There are times when Gold moves x%, and Gold equity also moves x%, in the same direction. At such times, the correlation between Gold and Gold equity is 1:1.
At other times, the levels of movement can be mismatched. For example, the correlation can be 0.8:1, or 1.2:1. Sometimes, there is even a negative correlation, when Gold moves in one direction, and Gold equity in the other. At still other times, one moves, and the other doesn’t move at all, i.e. there is no correlation.
You see, Gold equity first falls under the asset class of equity. It is linked to the mass psychology of equity. When this mass psychology coincides with the mass psychology towards commodities, here specifically Gold, there is correlation. When there is no overlap between these psychologies, there is no correlation. When the public just dumps equity in general and embraces commodities, or vice-versa, there is negative correlation. These relationships can be used for all commodities versus their corresponding commodity equity.
What does this mean for us?
Over the long-term, fundamentals have a chance to shine through, and if there is steady and rising demand for a commodity, this will reflect in the corresponding commodity equity. Over the long term, the discussed correlation is good, since truth shines forth with time. That’s good news for long-term investors.
Over the medium-term, you’ll see correlation at times. Then you’ll see no correlation. You’ll also see negative correlation. Position traders can utilize this information to their benefit, both in the long and the short direction.
Over the short-term, things get very hap-hazard and confusing. It would be wrong to look for and talk in terms of correlation here. In the short-term, for trading purposes, it is better to treat commodity as commodity and commodity equity as equity. If you are trading equity, a gold mining stock or any other commodity equity stock might or might not come up in your trade scan. When such a stock does get singled out for a trade as per your scan, well, then, take the trade. Don’t be surprised if at the same time your friend the commodities trader is trading oil futures instead, or is just sitting out. That’s him or her responding to his or her scan. You respond to your scan. In the world of short-term trading, it is hazardous to mix and correlate commodities with commodity equity.
Phew, that’s it for now. It’s taken me a long time to understand commodity equity, and I thought that I’d share whatever I understood with you.