By Charlie Bilello, CMT, Pension Partners
What do Lumber and Gold have to do with volatility in equities? As it turns out, more than you might think. In our third research paper which recently received the 2015 Wagner Award from NAAIM, we uncover a powerful intermarket relationship between these two seemingly disparate commodities and the environment for equities.
Lumber’s sensitivity to housing, a key source of domestic economic growth in the U.S., makes it a unique commodity as it pertains to macro fundamentals and risk-seeking behavior. On the opposite end of the spectrum is Gold, which is distinctive in that it historically exhibits safe-haven properties during periods of heightened volatility and stock market stress.
When you look at a ratio of Lumber to Gold, it is telling you something about the risk appetite of investors and the relative strength or weakness in economic conditions. When Lumber is leading Gold, volatility in equities tends to fall going forward. When Gold is leading Lumber, the opposite is true, and equity volatility tends to rise. The difference in historical volatility at nearly 6% per year is substantial, and as we outline in the paper which will be released in May, it allows an investors to position offensively or defensively in advance.
What is the relationship showing today?
Lumber has been falling precipitously since the start of the year and underperforming Gold significantly over the past three months.
Historically, this has preceded higher volatility and more difficult equity markets looking ahead. U.S. stocks were roughly flat in the first quarter and volatility remains near historic lows. But the relationship between Lumber and Gold is suggesting that conditions may be changing.
We are perhaps seeing this already in the economic data with the Bloomberg Economic Surprise Index currently at its lowest level since March 2009. Economic data continues come in weaker than expected, with misses last week in Retail Sales, Industrial Production, Housing Starts, and Building Permits.
Thus far, investors have shrugged this off as a positive for stocks because it means the Federal Reserve may be more patient in raising interest rates. Indeed, after the latest string of weaker data, expectations for the first rate hike have been pushed all the way back to December.
This has provided much comfort to investors who have become increasingly dependent on a continuation of 0% interest rates (which will hit 7 years in December). Should this weakness persist, though, it will likely become harder to dismiss regardless of how dovish Fed comments may be. At the very least, if history is any guide, we should be prepared for higher volatility ahead.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Courtesy Charlie Bilello, CMT, Pension PartnersThe views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle