Commodity Price Co-Movements: Back to Normal

We present evidence overruling the claim that commodity prices over the recent ten years have been moving increasingly and permanently more in sync in the short term. True, correlations across physically unrelated commodities increased during the commodity boom-and-bust and the financial crisis. However, even during this period short-term commodity price changes were far from uniform in terms of covariances and distributions. Applying Principal Component Analysis (PCA) to weekly price changes for 14 different commodities during the period 2007-08, the first principal factor explains less than 50 per cent of total variation and more than five factors are required in order to explain more than 80 per cent. Since 2009 the covariance structure has evolved so that the first principal factor explains far less. After 2012, no single factor explains more than 25 per cent and seven factors are needed in order to explain more than 80 per cent. This is quite similar to the results from the PCA for the period 1990-2006, suggesting that the covariance structure has reverted back to what was normal prior to 2007. The large growth in commodity futures trading and commodity investments – often referred to as commodity “financialization” - has not turned commodities into “one” asset. Prices of different commodities behave differently.