Oil Prices and Dollars

This Article is a week old

Crude futures jumped back over the US$50 mark today. And as you might guess, stocks and the US dollar went lower. There are rumblings that oil exporters and Russia are converting dollars into euros and that's pressuring the dollar. But should that have an effect on crude?

Actually, yes.

It seems that anytime oil rises, the dollar falls. If you superimpose a US dollar chart over a crude chart, you'll clearly see the relationship. But it's important to understand that the relationship is not casual. Like gold, oil should rise when the dollar drops.

That's because crude oil is denominated in US dollars. Forget supply and demand dynamics for a minute. Forget China's insatiable appetite for crude. Ignore the financial media's fixation on weather reports for the Northeastern United States and what that means for heating oil.

The single biggest force on the price of oil is the US dollar. And that's because the price of oil represents the real buying power of the dollar.
It's not a fixed peg that implies a benefit, such as can be found with the US trade deficit.

Since 2000, the US dollar has lost around half its value. Crude oil consistently traded below US$20 a barrel during the late 1990's. And it wasn't until OPEC adopted the US$22-to-US$28 price band on March 28, 2000, that crude prices got above US$20 a barrel for good.

Stocks are down today because of the appearance of that US$50-a-barrel price on the tape. But if the stock market was going to crash because of high oil prices, it would have done so already. The fact is, US GDP growth is largely immune to higher oil prices, as we've seen.

The US economy grew at a 3.1% rate in the fourth quarter. Crude prices ran between US$45 and US$55 during that same period. Low interest rates and rising income will keep US consumers spending enough to maintain US GDP growth at 3% to 3.5% - regardless of whether crude futures are trading for
US$40 or US$50 a barrel.

Most oil analysts expect flat to lower prices for the remainder of the year. And yet nobody is willing to go on record and predict a rally for the US dollar. But, interestingly, one of the biggest dollar bears in the world over the last few years, George Soros, isn't forecasting more declines for the US dollar. Rather, he's linked its fate to crude prices.

Now, a guy like Soros can always be expected to talk his position. If he wants to cover a dollar short, he'll say publicly that the dollar is going down. So in light of his apparent candor, I can only assume that Soros currently has no position in the US dollar. Maybe he's long the euro.

There's one thing that all the hand wringing about the dollar and oil proves - there is an abundance of fear in the market right now. This despite the fact that the economy is on pace for 3% to 3.5% growth, the forward P/E for the S&P 500 is moderate at around 20, fourth-quarter earnings were above expectations, and economic data is coming in mostly as expected.

Cheers,

Briton L. Ryle
Chief Trading Strategist
Money-Flow Matrix