The Oil-Gold-Dollar Trinity :: Macroeconomic tail events drive co-movement among oil, gold, and the US dollar  Citi Research

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The Oil-Gold-Dollar Trinity
Macroeconomic tail events drive co-movement among oil, gold,
and the US dollar
 Commodities as a Macroeconomic Asset Class – The end of the Great Moderation
since the 2008 global financial crisis should bolster the emergence of commodities as a
“macroeconomic” asset class, driven by financial factors as well as traditional demandand-
supply relationships. In this report, we explore the inter-relationship between
commodities and currencies, specifically between crude oil, gold, and the US dollar.
 Macro-financial Linkages between Commodities and Currencies – The potential
economic and financial mechanisms linking commodities and currencies are many and
multi-faceted. Some, such as denomination and investor flight-to-safety, are driven by
financial considerations and likely operate at higher frequency. Others, such as current
account rebalancing, operate through slower economic rather than financial principles.
 Negative Relationship between Oil/Gold and the US Dollar – Rolling correlation and
regression studies provide compelling evidence that the relationship between the US
dollar and oil/gold is negative, i.e. higher dollar returns are associated with lower oil
and gold returns. Evidence also suggests that causality flows from the dollar to oil and
gold but not the reverse.
 Structural Change in Relationship since 2004 – The negative relationship between
oil and dollar returns has structurally sharpened since 2004, possibly reflecting the
increased “financialization” of oil markets and the proliferation of commodity investment
vehicles. Meanwhile, there is also evidence of a similar shift in gold-dollar correlations
but is not as statistically significant.
 Co-Movement at Different Frequencies – We demonstrate that the oil-dollar
relationship is strongest using daily returns and weakens using weekly and monthly
returns. Meanwhile, the gold-dollar relationship does not appear to materially change
across different frequencies.
 Tails Drive the Co-Movement – We also demonstrate that the oil-dollar relationship is
driven by co-movement at the tails of their respective returns distributions, i.e. when the
dollar outperforms and oil underperforms, and vice versa. Perhaps surprisingly, the
relationship between gold and the dollar is strongest when both gold and the US dollar
underperform instead of the reverse.
 Relative-Value Strategy – Our analysis suggests market-neutrality is feasible using
extreme out-of-the-money options for oil, gold, and the euro/dollar exchange rate. We
suggest a long-short relative value strategy that goes long euro calls and short oil calls
and gold puts and discuss its potential efficacy in the current economic environment.