Oil & Alt Energy Redux

Charles Morand



Last
week, I conducted an analysis showing the href="http://www.altenergystocks.com/archives/2009/10/crude_oil_alt_energy_the_nonrelationship_that_just_wont_go_away.html">lack
of evidence supporting claims that oil and alt energy returns are
strongly correlated (claims that
sometimes
come from outfits as reputable as href="http://www.altenergystocks.com/assets/alt%20energy%20oct%202009.pdf">Bank
of America Merrill Lynch).
   



I don't want to belabor this topic but I thought I would post the
results of
another, similar analysis I conducted following comments I received on
how to improve the first one. In a nutshell, the comments suggested I
do the following:



1) Look at daily correlations or even smaller periods, as "common
knowledge" market movements can often dominate over the real
relationship in
the short and very short run



2) Look at absolute (price) correlations as well as relative (return)
correlations (my first analysis looked only at relative movements)



3) Look at directionality (i.e. what % of the time do assets X and Y
move in the same direction regardless of the size of the
move)



4) Extent your analysis to five years or greater



New
Analysis, Same Difference



The three sets of tables below
show daily return correlation coefficients, daily price correlation
coefficients and daily directionality statistics (% of days that the
assets close Up, Down or No Movement together) for oil, nat gas, the
S&P 500 and alt energy stocks.



The time periods have been extended from three to five years or since
inception. The
oldest alt energy ETF available is PBW that was listed
on March 03, 2005 - not quite 5 years
but a decent chunk of time nonetheless. The
other 3 ETFs (sector specific) were all listed in the 2^nd
half of 2008.





src="http://www.altenergystocks.com/assets/Correl%20Returns%20Oct%2014-09_3.bmp"
height="413" width="452">



src="http://www.altenergystocks.com/assets/Correl%20Prices%20Oct%2014-09.bmp"
height="413" width="452">





src="http://www.altenergystocks.com/assets/Correl%20Returns%20Oct%2014-09_2.bmp"
height="413" width="452">



The first set of tables show that returns on oil are not particularly
useful at explaining returns on alt energy stocks on a daily basis
(let's say that we enter useful
territory at 0.5 and above), although the results for PBW show the
relationship strengthening somewhat in the last year (which has been
anything but a normal year for the markets). These results are in line
with those from my href="http://www.altenergystocks.com/archives/2009/10/crude_oil_alt_energy_the_nonrelationship_that_just_wont_go_away.html">previous
analysis which looked at weekly
returns.



As far as absolute prices go (the second set of tables), correlation
coefficients for oil and alt energy are high, but they are just as high
if not higher for alt energy and the S&P 500. PBW shows the
relationship strengthening over time, but it strengthened even more
between oil and the S&P 500, something Tom opined href="http://www.altenergystocks.com/archives/2009/03/do_you_need_to_invest_in_oil_to_benefit_from_expensive_oil.html#comments">might
be the case a few months ago.



I don't find absolute price correlations all that useful. In
the medium and long terms, returns matter far more than absolute
prices. If a $1 movement in oil consistently results in a $1 movement
in an alt energy ETF over the long run, the high coefficient could
obscure a divergence trend between the returns on both assets as their prices rise.



Finally, the directionality tables (note that assets appear in a
different order) show a fair bit of co-directionality between oil and
alt energy (with the exception of PTRP [alternative transportation], something href="http://www.altenergystocks.com/archives/2009/10/crude_oil_alt_energy_the_nonrelationship_that_just_wont_go_away.html#comments">Tom
and I discussed last week). But
here again, the S&P 500 emerges as the stronger predictor.



Conclusion



I did not go any more granular than daily data: anything beyond that
becomes relevant only to traders.



Once again, the general conclusion that emerges from this analysis is
that oil - whether in terms of returns, prices or directionality - is
not a particularly useful indicator to go by when investing in alt
energy stocks, especially when compared to equity markets in general
(i.e. the S&P 500).



The implication for investors is that they should not invest in alt
energy as a hedge against or a play on href="http://www.altenergystocks.com/archives/2009/09/what_is_peak_oil.html">rising
oil prices. If anything, what
little relationship does exist will probably tend to disappear overtime
as alt energy and cleantech stocks respond more to core business
fundamentals than
to seemingly logical yet unproven narratives about external drivers.
 



DISCLOSURE: None