New tendency in correlations between bitcoin and financial instruments
Today more and more large investors acquire bitcoins as a part of their diversified portfolio. At the beginning of 2016 everyone used to talk about bitcoin’s low correlation with the most popular financial instruments. This was true back in 2014, 2015 and at first two quarters of 2016. At that time bitcoin’s correlation with the vast majority of financial instruments between -0.4 and 0.4. Today, however, situation has changed. Let’s take a closer look at rolling yearly correlation between bitcoin and six financial instruments:
- Crude oil (WTI — CL);
- Gold (GC);
- S&P500 (ES);
- EURUSD exchange rate (E6);
- Dollar Index (DX);
- 10 Treasury Notes (TY).
It’s clearly seen that bitcoin’s correlation with different financial instruments shows some interesting behavior. In particular, pay attention to correlation spikes. Why this happens? First of all, it’s because of trending movements on all of the aforementioned markets. Any longterm directional movements lead to higher, in absolute terms, correlation with bitcoin. This tendency is most clearly depicted on BTC-ES chart. What follows this new behavioral patterns? There are a lot of conclusions, but we focus on the most important one. Diversification benefit from including bitcoin in a portfolio fluctuates a lot now (This statement doesn’t mean bitcoin has become a bad investment). Financial and cryptocurrenchy markets now force investors to closely monitor instruments correlations in order to manage their risk and positions size.
To sum up, I’d like to point out, that even though correlation is a popular tool for relationship analysis, we should not forget it’s disadvantages. Correlation measures only linear relationship and doesn’t imply cause-and-effect relationship. For example, correlation between x and y (where y = x²) is zero, and correlation between bitcoin and coffee (there are no cause-and-effect relationship at all between this two products) is, on the contrary, quite high as it is show on the chart below.
