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In the financial markets, investors have enormous capacity for following a "rule of thumb" as long as they can. Then that rule, so successful for so long, suddenly runs out of gas with little or no notice. At that point, often with overwhelming evidence and reduced capital in hand, investors shift their attention elsewhere. It's a script that plays in a so-far-endless loop.
And that loop is currently playing in commodities. By many measures, the internal relationships among commodities as well as comparisons with other asset classes changed dramatically during the financial crisis when compared with the preceding decade and a half. Moreover, those changes persist.
Figure 1 shows the rolling 36-month correlation between commodities (as measured by the Dow Jones-UBS Commodity Index) and U.S. equities (S&P 500), developed market equities (MSCI EAFE), emerging market equities (MSCI EM) and U.S. real estate (Dow Jones U.S. Select REIT Index). Between 1993 and 2008, the commodities market correlation with each of these other markets generally bounced around between 0.00 and 0.40, with more observations happily below 0.00 than above 0.40. This characteristic partly explains the growth in acceptance of commodities as a distinct asset class that could bring significant diversification benefits to an investor's portfolio.
But that long-standing dynamic between commodities and other markets changed during the financial crisis. Correlations spiked above the soft 0.40 ceiling and have since continued to climb. Generally, correlations now stand in the 0.70-0.80 range, except for REITs, which is approximately 0.52. These are the highest levels in at least two decades.