Can someone explain the Oil vs Indexes correlation?

Discussion in 'Index Futures' started by fseitun, Dec 20, 2006.

  1. fseitun


    In a previous thread, I read someone mentioned that ER2 is positively correlated with oil.

    I too have noticed this type of correlation, yet after I did some research into Russell 2000 composition, I have found out that:

    Sector % of Index

    Financial Services 21.4%
    Industrial Materials 14.9%
    Healthcare 12.4%
    Business Services 10.6%
    Hardware 9.9%
    Consumer Services 9.0%
    Consumer Goods 5.3%
    Software 4.9%
    Energy 4.8%
    Utilities 3.0%

    According to the above numbers, oil would directly impact the Energy sector, which accounts for 4.8%.

    The financial services, industrial materials and healthcare sectors count for much more than Energy sector.

    Why do we have a direct correlation between ER2 and oil then?
  2. the common denominator you're looking for is probably the US dollar. if the dollar is falling, everything priced in dollars is rising assuming a constant 'real' asset value
  3. that was me that mentioned ER2's correlation

    the REASON is that ER2 is disproportionately (compared to YM or ES) composed of stocks that are in the oil industry and/or leveraged to oil

    it's HARDLY a proxy for crude prices, but -- for example - if oil is down HARD for the day (2%+), ER2 is not gonna be strong.
  4. fseitun



    With "stocks leveraged to oil" you mean those stocks whose PnL is affected by oil prices, like transportation for example?
  5. There is not always going to be a direct correlation, so keep that in mind. Right now there might be a correlation, but it will not last long, so be prepared for the correlation to eventually fail.
  6. mrmoose


    i allways thought that a good idea for an index or an etf was the ES ex oil
  7. the question got me curious so i just ran a quick corr matrix on a year of close prices for er2, qm and dxy. both er2 and qm corr more strongly to the dollar then they do to each other. fwiw..
  8. the dollar is often an indicator for many commodities, fwiw.

    if you are trading commodities and u are not watching to dollar index, you should be
  9. if you are trading ANYthing priced in dollars, or attemping to manage wealth, and you are not watching the dollar index... you should be


    regardless the majority of your er2 / crude relationship is explained via the dollar