London, 28 November 2011: Reuters

The correlation between commodity prices and the shares of companies that produce them has been weakening since the equity markets started slumping in August as the European debt crisis flared, hurting the global economic outlook.

This isn't that surprising as equities have a tendency to trade more on headlines and sentiment, while commodities have some semblance of being priced according to supply and demand fundamentals. However, looking at recent past experiences when the correlation has broken down, it has tended to be restored by the weaker component rallying rather than the stronger one slumping.

In this case it would imply that if the correlations were to reach more average levels, it would be because the equities rallied rather than the commodities declined. Given the current circumstances in the world economy this sounds counter-intuitive to my gut instinct.

Surely the prices of commodities are far more likely to slump given that the European sovereign debt crisis is seemingly endless and has boosted the chances of a world recession next year? Coupled with that there is now enough evidence to suggest that China, the driver of commodity demand growth, is slowing perhaps a tad more than is needed for a soft landing.

And to top it all off, the United States, the world's top oil consumer, is showing only lukewarm signs of growth and is vulnerable to a renewed global credit squeeze if the euro zone breaks up or has messy defaults by its mendicant states.

Nonetheless, several charts on the relative performance and correlations between resource companies and the commodities they produce show interesting results.

Exxon Mobil Corp.'s correlation to West Texas Intermediate crude oil has dropped to 0.29 as of Friday, down from as high as 0.86 in June. A reading of one shows the two securities move in perfect lockstep while zero means they have no correlation at all and minus 1 shows they are inversely correlated.

Exxon's correlation to WTI has spent much of this year and last above 0.6, however, at the start of this year it briefly dipped into negative territory. This was largely because crude oil dropped while Exxon's share price continued to rise.

The correlation was restored to levels above 0.5 by April this year because crude rallied harder than Exxon did. BHP Billiton , the world's largest miner and a crude oil producer, has also seen its correlation with the S&P GSCI index of commodities drop from a high this year of 0.79 on Oct. 11 to 0.598 on Friday.

The recent drop has been largely due to BHP shedding value faster than the index, similar to what happened at the beginning of 2011. The correlation went briefly negative in January and February as the index climbed and BHP flatlined, before both rallied from March.

Periods where the correlation dipped in around the middle of the year have been because of BHP's underperformance. Gold miners have also been underperforming the price of the precious metal. AngloGold Ashanti , the world's third-largest producer, saw its correlation to the spot gold price drop to 0.24 on Friday from 0.79 in September, while the measure has been above 0.5 for most of the time since June this year.

Similar to Exxon and BHP, the periods of low correlation have tended to be because the share price has declined while gold has risen, although in recent weeks AngloGold has outperformed the gold price.

I'm not going to pretend that this is some exhaustive or conclusive analysis of the correlation between resource companies and the prices of the commodities they produce. The three companies I chose are among the biggest in their fields and have solid history of reasonably strong correlations to the index or commodities to which they have been compared.

What the numbers show, is that in the past two years, when the correlation has dropped it's been restored by the component that fell gaining, rather than the one that was performing better turning weaker.

However, the equities have still underperformed the commodities since the start of 2010. A dollar invested in Exxon was by Friday worth $1.09, while it was worth $1.22 if allocated to WTI. For BHP the picture was worse, with the dollar being reduced to 84.8 cents while the S&P GSCI would give back $1.19. AngloGold returned $1.22 while gold was the outperformer at $1.78.

This shows that investors are getting a better deal by directly buying the commodities. But the correlation analysis suggests that equities, as the current weaker component, may gain more than commodities when the correlation is restored.

The risk is that the correlation doesn't come back for several months, or that this time it is different and the commodity prices drop to match the declines in the equities.

Ends --

The views expressed here are his own.