The world of financial markets is interconnected, and two of the most significant asset classes — commodities and stocks — often influence each other in both direct and indirect ways. Understanding the relationship between these two can help traders and investors optimize their portfolios and navigate the market more effectively.
In this article, we will explore the connection between commodities and stock market performance, and provide insights into how you can use this relationship to make smarter investment decisions.
- What Are Commodities and Stocks?
Commodities
Commodities are basic goods used in commerce that are interchangeable with other goods of the same type. They fall into two broad categories:
- Hard commodities: Typically natural resources like oil, gold, silver, and minerals.
- Soft commodities: Agricultural products like wheat, corn, coffee, and livestock.
Commodities are traded on specialized markets, such as the Commodity Exchange (COMEX), Chicago Mercantile Exchange (CME), and London Metal Exchange (LME).
Stocks
Stocks represent ownership in a company and entitle the shareholder to a portion of the company’s profits. Stocks are traded on exchanges such as the New York Stock Exchange (NYSE) or the NASDAQ, and they represent companies in various sectors like technology, finance, energy, and consumer goods.
- The Relationship Between Commodities and the Stock Market
While commodities and stocks are distinct asset classes, their performance is often linked by several key economic factors. Let’s look at the main ways they are connected:
- Economic Cycles and Growth
Both commodities and stocks are sensitive to the economic cycle — the fluctuations in economic activity over time, including periods of growth and contraction.
- During periods of economic expansion, demand for goods and services rises, which often leads to increased demand for commodities like oil, metals, and agricultural products. As a result, commodity prices tend to rise, and stocks in commodity-producing companies (such as oil companies or mining firms) tend to perform well.
- During recessions or economic slowdowns, demand for commodities falls, leading to lower prices. At the same time, stocks in cyclical sectors (like consumer discretionary or energy) often decline as businesses struggle with reduced demand.
- Inflation and Interest Rates
Both commodities and stocks react to inflation and interest rate changes, although their responses can differ:
- Commodities are often seen as a hedge against inflation. When inflation rises, the price of raw materials (like gold or oil) tends to increase. This is because inflation erodes the purchasing power of currencies, and commodities priced in those currencies become more expensive as a result.
- Stocks, on the other hand, can suffer from inflation. Rising costs can squeeze corporate profits, particularly for businesses with high operating expenses. To combat inflation, central banks may increase interest rates, which can depress stock market performance by raising borrowing costs for businesses and consumers.
- Correlation Between Commodities and Specific Sectors
Certain sectors of the stock market are directly tied to commodity prices:
- Energy stocks (e.g., ExxonMobil, Chevron) are highly correlated with oil prices. When oil prices rise, energy stocks generally perform well, as higher oil prices improve the profitability of oil-producing companies.
- Mining stocks (e.g., Barrick Gold, Rio Tinto) are linked to the prices of metals like gold, copper, and silver. When metal prices rise, mining companies often see increased revenue, which can lead to higher stock prices.
Similarly, declines in commodity prices can lead to weaker performance in these sectors.
- The Impact of Global Events
Geopolitical events, natural disasters, and policy changes can simultaneously affect both the commodities and stock markets:
- For example, geopolitical tensions in oil-producing regions can cause oil prices to spike, leading to higher energy stocks. Conversely, if these tensions lead to fears of an economic slowdown, the broader stock market may fall.
- Natural disasters, such as hurricanes, can disrupt agricultural production, leading to price hikes in soft commodities like corn and soybeans, which in turn can affect related sectors of the stock market.
- How Traders Use the Relationship Between Commodities and Stocks
Traders who understand the connection between commodities and stocks can use this information to create more robust trading strategies. Here’s how they can do it:
- Diversification with Commodities
Commodities often perform well when stocks are struggling. This makes them an ideal diversification tool in a portfolio. For example, if stocks are underperforming during a market downturn, gold and oil might act as a hedge and increase in value.
- Commodities can provide counter-cyclical protection.
- Energy stocks and mining stocks tend to rise with commodity prices, but other sectors might struggle during times of high inflation or rising rates.
- Hedging Against Inflation
As we’ve mentioned, commodities are often seen as a hedge against inflation. Traders might use commodity futures, ETFs, or physical assets like gold to protect their portfolios from rising inflation, which typically causes stock market volatility.
- Trade Pair Strategies
Some forex traders might use commodity currencies in a pair strategy:
- Canadian Dollar (CAD): Strongly correlated with oil prices since Canada is a major oil exporter.
- Australian Dollar (AUD): Correlated with metals and minerals because Australia is a major exporter of commodities like iron ore and gold.
Traders might use these correlations to take advantage of rising or falling commodity prices while trading forex.
- Trading Commodity-Linked Stocks
For stock traders, investing in commodity-linked stocks offers an opportunity to trade the broader commodity market indirectly. For example:
- Energy stocks (like BP and Shell) benefit when oil prices rise.
- Mining stocks (like Rio Tinto and Anglo American) rise when gold or copper prices appreciate.
- How to Manage the Risks of Commodities and Stock Market Volatility
While commodities and stocks can offer profitable opportunities, they also carry risks. Here’s how to manage those risks effectively:
- Understand Market Correlations
Not all commodities and stocks are correlated. Some commodities may move inversely to stock market performance, while others may move in the same direction. Understanding these relationships will help you make better trading decisions.
- Use Stop-Loss Orders
Both commodities and stocks can be volatile, so using stop-loss orders is essential for protecting your capital. This is especially important in times of geopolitical uncertainty or unexpected economic shocks.
- Stay Informed
Global events and economic reports affect both commodities and stocks. Keep an eye on:
- Commodity inventories (e.g., crude oil stockpiles, agricultural yields)
- Economic indicators (e.g., GDP growth, CPI, interest rates)
- Geopolitical tensions (e.g., trade wars, sanctions, natural disasters)
- Diversify Across Asset Classes
Diversification is key to managing risk in both commodity and stock markets. Rather than focusing on one asset type, consider a mix of commodities, stocks, and other asset classes (e.g., bonds, real estate) to hedge against volatility.
- The Bottom Line
Understanding the relationship between commodities and stocks is crucial for successful trading and investing. Commodities and stocks are closely linked to global economic events, and their price movements often correlate with changes in interest rates, inflation, and geopolitical tensions.
By diversifying across asset classes, using appropriate risk management strategies, and staying informed about global events, traders can take advantage of both markets’ opportunities while managing risk.
Stay informed and make smarter trading decisions by subscribing to the Für-Trade newsletter for regular updates, market insights, and expert strategies on trading commodities and stocks.