Do Commodities Lead the Equity Markets?

It is generally accepted that commodity prices can have an impact on equity markets, as the prices of commodities can affect the profitability and performance of companies in various sectors. For example, a rise in the price of oil may benefit companies in the energy sector, while a decline in the price of copper may negatively affect mining companies. However, the relationship between commodities and equity markets can be complex and can vary over time, depending on a variety of factors such as supply and demand dynamics, economic conditions, and market sentiment.

Reference [1] examined the lead-lag relationship between the commodity and equity markets. It concluded that the commodities lead the equity markets,

We find that price changes in a large number of commodity futures can predict movements in equity returns of US industry portfolios. The findings suggest that information contained in commodity prices only gradually diffuses across the financial market and is only priced by the relevant equities with a lag... Interestingly, we find little evidence of predictive power from commodities to industries with a strong economic link, suggesting that investors with specialisation within an industry efficiently incorporate information about the most relevant commodities. Instead, most of our statistically significant commodity predictors have a more obscure relationship with the respective industries they lead, indicating a complex relation that investors only incorporate into prices with a lag.

However, this leading relationship cannot be exploited to make excess returns,

Furthermore, we find that the identified predictive power of commodity futures cannot be utilised to generate abnormal returns in the financial market. Instead, we find that any excess return generated from our simple exploitative trading strategies is attributed to factor loading on the factors of the Fama-French five-factor model.

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References

[1] Justin Brackmann and Trygve Skjaeggestad, Do Commodities Lead Stock Market Industries?, 2022, BI Norwegian Business School.

Originally Published Here: Do Commodities Lead the Equity Markets?