What happens to other commodities when oil prices spike? On one hand, if oil rises so much that an economic slowdown overpowers the tax-break effect, then commodities might fall. However, oil is a main input to produce many other commodities, so the prices of goods can rise when oil prices increase. The latter scenario is more likely, given the historical relationship of energy to inflation and to other commodities.
One of the hallmarks of diversification in commodities is how lowly correlated they are to each other from the individual supply-and-demand models. Notice that the highest correlation between any two sectors in the chart below is 0.27.
Source: S&P Dow Jones Indices. Past performance is not an indication of future results.
The source of return that mainly drives the correlation between commodities to be unrelated is expectational variance or supply shocks. When oil price falls, it may be demand- or supply-driven, but most of the time the weakness has come from demand drops. When this happens, the correlation is higher between commodities, at about 0.40 on average. However, the recent moves (both down and up) have been driven more by supply than demand, as the case has been in many historical oil price spikes.
