11 Market Correlations You’ll Want to Use

11 Market Correlations You’ll Want to Use



Posted on September 11, 2007

Experienced futures traders know there are many correlations among futures markets
- some of which are valuable guides in helping to determine specific
market trends, and some of which are fickle. This educational feature
will examine some basic correlations among futures markets, and will
likely be most beneficial to the less-experienced traders. However, it
just might be a good refresher for the experienced traders who may have
forgotten a few of the market correlations.
It is important to emphasize that market correlations are never 100%
predictable, and that some market correlations can and do make
180-degree turns over a period of time.
U.S. Dollar-Gold: The gold market and the dollar
usually trade in an inverse relationship. This has been the case for
many years. During times of U.S. economic prosperity and lower
inflation, the dollar will usually benefit as money flows into U.S.
paper assets (stocks and bonds), while physical assets (gold) are
usually less attractive. Conversely, during times of weaker U.S.
economic growth, higher inflation or heightened world economic or
political uncertainty, traders and investors will tend to flock out of
“paper” assets and into “hard” assets such as gold. Inflation is a
bullish phenomenon for gold.
U.S. Dollar-U.S. Treasury Bonds: Usually, a
stronger dollar means a stronger bond market because of good demand for
U.S. dollars (from overseas investors) to buy U.S. T-Bonds. T-Bonds are
also seen as a “flight-to-quality” asset during times of economic or
political instability. In the past, the U.S. dollar has also benefited
from “flight-to-quality” asset moves. However, since the major
terrorist attacks on the U.S. and the resulting damage to the U.S.
economy, the safe-haven status of the “greenback” has been much less
pronounced.
Crude Oil-U.S. Treasury Bonds: If crude oil prices
rally strongly, that is a negative for U.S. T-Bond prices, due to
notions that inflationary pressures could reignite and become
problematic for the economy. Inflation is the arch enemy of the bond
market. Rising crude oil prices are also bullish for the gold market.
CRB-U.S. Treasury Bonds: The CRB Index is a basket
of commodities melded into one composite price. A rising CRB index
means generally rising commodities prices, and increasing inflation.
Thus, a rising CRB Index is negative for U.S. Treasury Bond prices.
U.S. Stock Indexes-U.S. Treasury Bonds: Since the
bull market in U.S. stocks ended just over two years ago, stock index
futures prices and U.S. Treasury bond futures prices have traded in an
inverse relationship. When stock prices are up, bond prices are usually
down. However, during the long bull market run that preceded the
current bear market, stock and bond prices traded in tandem. In fact,
years ago, before all the electronic overnight futures trading had
begun, the best way to get a good read on how the stock indexes would
open was by early trading in the T-bond market. (T-Bond trading opens
70 minutes before the stock indexes).
Silver-Soybeans: This corollary may be more fiction
than fact, at least nowadays. But during the “go-go” days of soaring
precious metals and soybean prices, it was said that if soybean futures
would lock limit-up, bean traders would buy silver futures.
Cattle-Hogs: The point to mention here is that if
strong price gains or losses occur in one meat futures complex, there
is likely to be somewhat of a spillover effect in the other meat
complex. For example, sharp losses in the cattle or feeder cattle
futures will likely weigh on the hogs and pork bellies.
Currency Futures-U.S. Dollar Index: Most major IMM
currency futures contracts are “crossed” against the U.S. dollar. Thus,
when the majority of the currencies are trading higher, it’s very
likely that the U.S. Dollar Index will be trading lower. It’s a good
idea for currency traders to keep a watchful eye on the U.S. Dollar
Index, as it’s the best barometer for the overall health of the U.S.
dollar versus major foreign currencies.
U.S. Stock Indexes-Lumber: Lumber is a very
important commodity for the U.S. economy. It is literally a building
block for the nation. If the stock market is sharply higher, lumber
futures prices will be supported. A big sell off in the stock market
will likely find selling pressure on lumber futures.
N.Y. Cocoa-British Pound: London cocoa futures
trading is as important (or even more important) than New York cocoa
futures trading, on a worldwide basis. London cocoa futures trading is
conducted in the British pound currency. Thus, big fluctuations in the
pound sterling will impact the price of U.S. cocoa futures, due to the
cross-currency fluctuations of the British pound versus the U.S.
dollar. Keep in mind there is constantly arbitrage taking place between
the New York and London cocoa markets, and thus the currency
cross-rates between the pound and the dollar are very important.
Grains-U.S. Dollar Index: A weaker U.S. dollar will
be an underlying positive for the U.S. grain futures markets because it
makes U.S. grain exports more competitive (cheaper prices) on the world
market. Larger-degree trends in the U.S. dollar will have a
larger-degree impact on the grains.

Jim Wyckoff

TradingEducation.com