Portfolio Heat: Correlation between Equities & Commodities


(click to enlarge spreadsheet)

If you haven’t heard, there was some news on the tape about Goldman Sachs on Friday regarding the SEC. Portfolio heat is high. Commodities and equities were down at the close because they’ve become highly correlated. Above is a spreadsheet with what was in the portfolios of many trend followers and commodity managers. The data are through Friday’s settlement.

When the correlation between commodities and equities runs high, you’ll get hammered and lose much more than you anticipated. More importantly, the client who owns the money will get hammered too. The above chart only includes the commodity portion. An endowment, pension, or macro hedge fund probably got hit on their equity exposure too.

It’s aggravating to get knocked out of a trade, but it’s much worse to lose your confidence – and that’s what big down days do to you. Once you start trading with scared money, you’re toast. If you find yourself saying, “WTF?” or “How can this happen?” you’re not in control of your risk, and maybe not of your emotions. Go to cash – I’ve seen lots of promising careers end in times when things become highly correlated.

If you’re not ready for this, go to cash until you figure it out. Last week, I wrote about what could be the cause of the next big financial crisis. I didn’t know the SEC was going to bring charges against GS any more than you did, but I have the tail risk hedged away.

With what looks like a conservative portfolio mix, and a low margin to equity ratio, a portfolio with $1 MM in corpus with such holdings would have been down almost 2% on the day. That is huge if you’re looking to run institutional money. For the record, a 2% “up day” would scare them away too.

Are all your holdings just one big trade?


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