I gave the basics of what it is in a
https://www.physicsforums.com/showpost.php?p=2907921&postcount=5", is simply the difference between the Hartree-Fock energy and the true energy.
But to address the question of physical meaning; it's generally described as the effect caused by electrons avoiding each other in their motion. Something I (hopefully) managed to illustrate in my previous post, which assumes a Hartree-Fock approach. (by assuming the electron-electron interaction can be described as a potential dependent only on the wavefunction of the other electron. I.e. a mean-field approach. )
Note that HF by construction obeys antisymmetry, so two electrons of the
same spin still have a zero probability of being in the same location at the same time, so in
this sense their motion is correlated. So the electrons of the same spin do still 'avoid' each other to some extent, it's merely the Coulomb repulsion correlation that's not taken into account. (The pair-density has a 'Fermi hole' but not a 'Coulomb hole') As cgk describes, there's also static correlation, which is related to the single-determinant nature of the Hartree-Fock approximation. This is a bit more relevant to MCSCF and the methods which build directly on Hartree-Fock.
So 'correlation', while usually physically described as the electrons "avoiding each other" doesn't actually include
all the dynamical effects (since Pauli repulsion is taken into account), and it also includes some non-dynamical effects caused by the single-determinant HF description. But the bulk of correlation energy is still the coulomb-correlation of motion.
In DFT, correlation is "exchange-correlation", because the Kohn-Sham approach does not describe either. In other words,
all dynamical effects are excluded. So the "functional" (within the KS methodology) only refers to this part. The exchange-correlation functionals are usually separated into a sum of exchange and correlation parts (although AFAIK, there is no rigorous theoretical justification for this. It does seem to work fairly well though).
In principle at least, static correlation has no meaning in DFT, because if the exact density functional were known, a single determinant description would be exact.