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TOPIC: The Dollar & Oil

The Dollar & Oil 7 months 3 weeks ago #1

  • Buckeye
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Saw this article by Charlie Bilello and thought it interesting....

http://www.marketwatch.com/story/chart-shows-whats-really-driving-crude-oil-prices-2016-04-11
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The Dollar & Oil 7 months 2 weeks ago #2

  • MichaelMedici
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He is correct.

Oil is denominated in dollars, a depreciation in the value of the dollar relative to foreign currencies increases foreign buying power essentially making oil cheaper for them to purchase. This increases the demand for oil and drives the price upward.

I believe the divergent monetary policy, with the US beginning to tighten in Summer '14 (Source: www.europac.com/commentaries/shadow_rate_casts_gloom)
played a major role in the initial sell off of oil. This topic was discussed as far back as Summer of '15 (Source: www.salientpartners.com/epsilon-theory/suddenly-last-summer/)

With a knowledge of monetary policy, You can look back as far as '07 and see a correlation with the dollar and oil. Check out the chart in this article. oilprice.com/Energy/Oil-Prices/Why-The-O...S.-Shales-Fault.html. The main thing that sticks out to me is, If oil prices were really determined by supply demand imbalances, and not the Free Money being poured into the shale patch thanks to QE from the Fed, wouldn't oil prices have remained relatively stable between Jan '09 - May '11 as no clear supply-demand imbalance existed? That's where I initially recognized the correlation.

Eventually, however, what happens is that the sentiment game comes into play. That is, people (CNBC and others) begin saying that the decrease in oil price is caused by supply demand imbalances, and the more it is talked about the more it becomes reality. So, despite the fact that the dollar and oil are highly correlated, supply and demand news plays a major role in the price of oil, simply because that is what everyone believes everyone else cares about. It is great to recognize that the dollar does have effect, and is another thing to think about/pay attention to.

My views are in line with Erik's regarding the supply-demand imbalance as well as the future of the Fed's inability to raise interest rates and possibility of already being in a recession. I see this combination resulting in a short term decrease in the price of oil, as supply demand factors remain a major influence, but then a roaring recovery as a supply shortage hits and is combined with easing from the Fed to prevent a recession and thus, a weaker dollar, making oil cheaper for foreign buyers and driving demand up.

Hope this all makes sense, let me know if you have any questions!
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The Dollar & Oil 7 months 2 weeks ago #3

  • TraderMatt
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I completely agree with Michael on this.
In fact - I've put together the below chart showing that this is not specific to oil at the moment.
Most commodities have been tracking an inverse correlation to the US dollar since it went on it's bull run in 2014.

In my lowly opinion, what I read from the chart is that supply and demand is currently playing second fiddle to the dollar move.
The higher the inverse correlation, the more conviction I have that the move has less to do with the fundamentals of the underlying commodity and more of a reaction to the dollar denominated commodity.

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The Dollar & Oil 7 months 1 week ago #4

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One additional thought I would like to make in the connection between the Dollar (The Fed) and oil.

In a (hypothetical) situation where the Fed acknowledges we are heading into a recession, cuts interest rates again and even provides helicopter money (potentially in the form of a War) what direction does oil go?

My logical thought would be rate cut / more QE = economy is not strong and demand decreases, but based on the "dont' fight the Fed" that still prevails I believe it is possible that the devaluation of the dollar that would occur with a rate cut / QE and/or the increased demand from a War would actually INCREASE demand for oil and send prices sky rocketing upwards as the Supply/Demand imbalance is fixed from the Demand side.

Would love to here @ErikTownsend opinion on this thought.
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The Dollar & Oil 7 months 1 week ago #5

  • ErikTownsend
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@MichaelMedici

I think a lot about this - thanks for a fantastic question!

I generally agree with your comment that it could go either way, in the sense that more QE = "Oh no!" for the economy = less demand. But also more QE = more easy money = more malinvestment. So it really depends on the structure and nature of the QE. I don't expect the next one to look like the last three. More along the QE for the people theme - infrastructure spending, transfer payments, etc.

But more to the point, I think that demand is just not as important as supply right now. Put another way, there is only so much market imbalance "swing" that can be attributed to natural growth or slowing of demand. Of course a recession lower demand, but I contend the extent that demand drops is relatively small in terms of the supply-demand imbalance it causes. Contrast with the current Saudi-driven "market share" agenda, leading to a HUGE oversupply.

Or I guess maybe a better analogy is aiming a fire hose into an oncoming tidal wave. Of course the water from the fire hose is important in most circumstances. But dude, this man-made oversupply situation was concocted by KSA/UAE/Kuwait, and the demand destruction caused by a U.S. recession will look like noise (fire hose) to them (tidal wave). QE from the fed is another matter entirely, and precisely what they DON'T want to let happen is another big round of mal-investment in shale. But they're not stupid. They've already thought about QE, and they have a plan for what to do if another round of QE is announced. I have no idea what that plan is, but they do. No doubt in my mind on that one!

Best,
Erik
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The Dollar & Oil 7 months 6 days ago #6

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ErikTownsend wrote:
@MichaelMedici

Or I guess maybe a better analogy is aiming a fire hose into an oncoming tidal wave. Of course the water from the fire hose is important in most circumstances. But dude, this man-made oversupply situation was concocted by KSA/UAE/Kuwait, and the demand destruction caused by a U.S. recession will look like noise (fire hose) to them (tidal wave). QE from the fed is another matter entirely, and precisely what they DON'T want to let happen is another big round of mal-investment in shale. But they're not stupid. They've already thought about QE, and they have a plan for what to do if another round of QE is announced. I have no idea what that plan is, but they do. No doubt in my mind on that one!

Best,
Erik

That seems to be the "game" these days......to guess where the created money is being sent and go there to "catch" it (slurp it up)....sort of the "don't fight the FED" mantra. Well, if this is how things go...we are in for a sad situation for those overlords sloshing around that QE money are not likely any wiser that those who sloshed the prior money into those prior mal-investments.....but that 'might" very well be the only game in town.

I think not, though I am not exactly sure what the BEST course to take is. I do think that some means of "disconnecting" from the larger money system might be a better plan......my thoughts to to the Amish people who sort of create an eco-system of their own and actually try their best to stay in their own world. Yes, they trade and connect with our world many times over......and they benefit (and get hurt) from it as well. But if the world went to hell, I think they would also exist in their own ecosystem that would allow the sort of trading, and cooperation for their continued progress (such as it is) to exist.

NO, I am not suggest we convert to Amish.....just to think more about how we might work to "detach" from dependency the greater economic system and become a part of a smaller, more open market system. (if it were easy, everyone could do it and we could all go home rich)
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MACRO VOICES is presented for informational and entertainment purposes only. The information presented in MACRO VOICES should NOT be construed as investment advice. Always consult a licensed investment professional before making important investment decisions. The opinions expressed on MACRO VOICES are those of the participants. MACRO VOICES, its producers, and hosts Erik Townsend and Nathan Egger shall NOT be liable for losses resulting from investment decisions based on information or viewpoints presented on MACRO VOICES.

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