New Stock Correlations: Proper Diversification of Investments; Oil and Natural Gas Are Perfect

At the end of every month we compute the correlations of all major indices and stocks. May was a very volatile month. This raises questions as to possible the effects on correlations.

Correlations are very important and useful for proper investment diversification. Two stocks that are highly correlated, with correlation values close to +1 or -1, do not provide sector diversification. In general, one may be used as a replacement for the other.

Below is a table showing the values for the period April and May 2010 for major stock indices and ETFs.


(please click to enlarge)

To diversify, green and red shaded pairs should be avoided.

Some of best uncorrelated pairs are:

• GDX and BZF (gold miners and Brazilian Real) and FXY (Yen)
• GDX and IWM (Russel 2000), XLU (utilities), XLY (cons. discretionary)
• UUP (dollar) and UNG (nat. gas), a perfect 0.00
• USO (oil) and UNG (natural gas)

Next time someone tells you that natural gas can be used a replacement for oil, remember that!

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