Commodities & Stocks: Understanding the Interplay

Stocks and commodities are often trading the exact same resource. We think of the commodity market as the purchasing and sale of the good, often times separate from the stock market. However, there are a number of commodity companies that trade equity on the market. There are also indices tracking commodities and bonds held in the value of commodities. In this way, the markets interact because they are, essentially, the same market.

#1 Indices and Bond Purchases

An example of an index that tracks commodities is the Goldman Sachs Commodities Index (GSCI), now called the S&P GSCI. This index, just like the S&P 500, tracks a variety of different securities. Investors can purchase funds based on this index without actually buying into the "commodity market." When the prices of individual commodities drop, this index and other commodities indices will also drop, showing the interaction between securities in a fund and the underlying price of the commodities. This is not only true of indices. You may have purchased a gold bond in recent years. With a gold bond, your currency was converted into gold, and the value of your bond trades at the value of the underlying gold asset.

#2 Commodity-Linked Stocks

Beyond these obvious interactions, there are some more nuanced convergences in the two markets. One example is stocks that belong to commodity-based businesses. For example, you could purchase barrels of crude oil on the commodities market. You could also purchase shares in an oil refinery company. In both cases, you are buying into the oil market. If the price of crude oil goes up in the commodity market, the value of refined oil will also go up, meaning the stock you hold in the refinery business will grow in value. This is called a market convergence.

#3 Commodity and Stock Divergence

There are times when the relationship between commodities and stocks in a similar field diverge instead of converge. For example, in 2008, the price of crude oil peaked then fell, but the cost of gasoline held constant for some time. This divergence typically will not last long. Analysts look for this type of divergence to show when a market may be topping out or preparing for a bullish run. For example, if the cost of crude oil begins to creep higher, purchasing stocks in refineries may be a chance to get into the next market that will experience growth prior to the growth actually beginning.

#4 Anomalies and Outliers

Of course, the commodity market is not 100 percent predictable. There are times when a divergence that should signify a coming convergence does not produce the anticipated results. Gas prices do not follow oil prices because there is a hurricane in the Gulf, and five key refineries are wiped out, keeping refined oil prices high. The corn crop is wiped out in a freeze, but the price of corn fails to rise because last year's stock was superfluous. These outliers can be tracked to seek patterns, but they are often times no more than outliers. At times, commodity prices and stocks do not have a predictable relationship.