How reliable is the diversification commodities are sold for?
The standard case for commodity exposure is a single statistic: low long-run correlation with equities. The statistic is accurate. It is also one of the most misleading numbers in finance, because the correlation is not a constant — it is a different number depending on why the world is moving.
An average hides the thing you care about
Over long samples, the correlation between broad commodities and equities has often been close to zero. But run it as a rolling correlation and it wanders across a wide range — deeply negative in some three-year windows, strongly positive in others. Averaging those two states produces a number that describes neither.
What actually determines the state is the type of shock:
- Demand shocks — correlation goes up. A recession or a financial crisis cuts corporate earnings and industrial commodity demand. Both fall together. 2008 is the canonical case: commodities and equities collapsed side by side, and the diversification vanished at precisely the moment it was wanted.
- Supply shocks — correlation goes negative. An energy shock raises input costs (bad for most companies) while raising the commodity's own price. 2022 is the canonical case: commodities rose while equities and bonds fell together, and the diversification worked exactly as advertised.
So the property being sold is state-dependent: it has tended to work in inflation and supply-shock states and to fail in liquidation states. That is a genuinely useful thing to know — and a very different claim from "commodities are uncorrelated".
The two structural facts underneath
No income. A share pays dividends, a bond pays coupons, a property pays rent. A tonne of copper pays nothing, and storing it costs money. There is no cash flow to discount, which also means the valuation tools from Fundamental Analysis have nothing to bite on. Whatever return exists comes from the price and from the mechanics of the exposure route — futures roll and collateral yield, covered in Roll yield over several periods.
High volatility. Broad commodity baskets have historically run at volatility comparable to equities or higher, and single commodities far above that — natural gas has spent long stretches at several times equity volatility. A position size that feels ordinary in an equity context is not ordinary here, and the same percentage allocation contributes far more risk than it does weight.
A worked example
Rounded, illustrative. A portfolio is 60% equities at 16% volatility and 10% in a commodity basket at 30% volatility.
- Equity risk contribution scales with 0.60 × 16 = 9.6.
- Commodity risk contribution scales with 0.10 × 30 = 3.0.
Before any correlation effects, a 10% weight is carrying roughly a third as much risk as a 60% weight. Ignoring the volatility difference and thinking in weights alone systematically understates what the exposure is doing — one of the most common errors in this asset class.
The honest summary
Commodities are a no-income, high-volatility exposure whose correlation with equities is real but unstable, and whose diversification benefit shows up in some crises and disappears in others. None of that says own them or avoid them. It says what the exposure is — and knowing what something is, rather than what it is marketed as, is the entire purpose of this course. Portfolio decisions belong with your own objectives and a qualified adviser.
Try it now
- The longest crude history and the longest broad-equity history this page holds are below. Switch both to Monthly. Now go year by year and mark each one U (both up), D (both down) or S (split). You are computing a correlation by hand, badly, which is the fastest way to stop trusting one number.
- Isolate 2008 and 2022 specifically. In one they fell together; in the other they moved apart. Name the shock type behind each — a demand collapse hits both, a supply shock hits one and helps the other.
- Measure the largest drawdown on each chart. If the commodity's is materially larger, restate what a "10% allocation" actually means once you express it in risk rather than in capital.