Decoupling

Decoupling

Decoupling is when one asset class starts behaving in a pattern that is different from its expected pattern. This behaviour is generally seen between oil and gas prices, which tend to increase or decrease together, but due to certain events their prices can move separately in case of decoupling. 

This is also something that is usually seen in gold and US dollar prices that are decoupled and tend to flow in the opposite direction from each other. 

What Is decoupling? 

In the world of finance, decoupling refers to prices or returns of an asset that begin to divert from the expected pattern. Hence, it is said to be decoupled. Decoupling happens when two asset classes that were behaving similarly begin to break their usual pattern at some point and starts showing signs of different behaviours. 

Understanding decoupling 

Understanding decoupling can be the key to saving your assets from bad investments. If one of your assets is coupled with another asset, you risk losing the value of both assets if the value of one falls. Investors use a measure called correlation to accurately calculate the relationship between two assets. How strong the correlation between two or more assets is, depends heavily on the metric range between -1 and +1. If the correlation between two or more assets turns out to be +1, then that means the two assets will follow the same pattern, but if that value is -1, then that indicates that the two assets will follow a pattern opposite of one other. This value allows investors to diversify their assets by investing in assets that are in no way correlated with one another. So, if the value of one asset decreases, the others won’t go down the same route. 

Decoupling of markets 

Economies and markets are not an exception to decoupling. One example would be the Great Recession that happened sometime in 2008. It originally started in the US but due to the coupled nature of the economy, but it soon started happening globally leading to a global recession. A coupled economy allows other economies to benefit when the one big economy, such as the US economy, benefits. But the opposite can also be true. Decoupling of markets and the economy can save them from the fall of the other. 

Importance of decoupling 

Decoupling plays an important role in the financial world and it can impact the following sectors. 

  • Financial markets 

Decoupling can impact several financial markets, including stocks, bonds, indexes, and more. They could be correlated to each other now, but that may not always be the case. At some point, they will part ways and decouple from each other, whether it’s gold and US dollars; or the US economy and an emerging economy. 

  • Environment and the economy 

The economy and the environment usually tends to go in opposite directions. Whenever there’s significant economic growth, the environment tends to suffer. For example, growth in the economy due to higher sales of fossil fuels comes at the cost of the environment. But that shouldn’t be the case and that’s what makes decoupling so important. Decoupling the growth and development of the economy from the environment will minimise its impact and influence on one another. 

Examples of decoupling 

The correlation between developed and emerging markets often experience decoupling. Usually, developed markets are in sync with emerging markets, but can be prone to decoupling. For example, sometime in late 2017, the emerging market starts gaining significant value as compared to its developed counterpart, showing signs of a break in pattern and decoupling, which continued till 2019. 

Frequently Asked Questions

If you break down the word decoupling, the “de” in the word means the opposite and “coupling” means together. Altogether, the word means opposite of together. One example of coupling would be the value of gold and gold mining stocks. When the value of gold increases, the value of gold mining stocks also increase. Decoupling would mean the value of one asset decreases compared to the value of the other, which is the case with gold and US dollars. When the value of gold increases, the value of dollars decrease in comparison. 

Decoupling refers to one asset that is diverging in a different direction compared to the other asset. While recoupling refers to two or more assets whose paths lead in the same direction once again. One example of recoupling could be the correlation between developed and emerging markets that were temporarily decoupled in 2017, but by the end of 2019, they recoupled. So, the value of both developed and emerging markets followed the same pattern. 

Utility rate decoupling refers to the decoupling of the utility’s revenue from the revenue generated by the energy products. In theory, the utility rate should depend on the meeting the client’s energy needs, but in practice, it depends on the sale of the energy products instead. Utility rate decoupling would refer to decoupling the utility rate from the energy product’s profits. 

The United Nations came up with a Sustainable Development Goals plan to create long-term projects whose purpose was to allow markets and economies to grow while reducing their negative impact on the environment. This can be done by reducing the reliance on practices and mechanism that harms the environment or release hazardous materials that are harmful to the environment. 

For a business to thrive in this competitive market, the company would need to devise a strategy in place that is aligned with the market requirements. Research seems to suggest a lot of interest in businesses to adopt the Customer Order Decoupling Point. The Customer Order Decoupling Point is a specific point in the material flow where a commodity is directly tethered to a customer order. There will always be one dominant Customer Order Decoupling Point in the flow of any supply chain. 

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