After a long holiday weekend in the US and with few news snippets circulating on the wires the market is starting the week off on a bit of a negative note. A slightly stronger dollar and a new round of talks between the West and Iran are also contributing to the overnight selling in oil. Two facts remain…the long term uptrend is well intact and the price of oil is still very overvalued and susceptible to a downside correction. The market has undergone short and shallow corrections but nothing of substance in a long time. We still believe the dollar will be one of the main catalysts if and when the complex moves seriously to the downside.
Since 2007 the dollar has been fairly well correlated to the price of oil. As shown in the following table of dollar/euro gains versus WTI gains for 2007 and 2008 to date the movement of both of these instruments remains fairly consistent. The correlation coefficient decreased a bit this year dropping to 0.735 from 0.792 in 2007. With WTI gains year to date strongly exceeding 2007 while the dollar/Euro has not kept exact pace with 2007 gains it would suggest that the dollar is not the sole catalyst that is moving oil. Although it is a major influence other issues like supply & demand, Geopolitics, declining inventories, etc are all contributing to the meteoric gains in the price of oil this year. Also we can’t discount the fact that oil is just simply overvalued at this point in time.
These data suggest that we need to watch the dollar relationships versus the major currencies around the world as one of the leading indicators as to the next major move in oil prices. If the dollar falls strongly oil will surge and if the dollar rises strongly oil will fall. The latest comments coming out of the EU were a bit less hawkish than expected and as such the dollar has regained some footing over the last few days and is once again approaching a major upside breakout resistance level. If the dollar/Euro drops below and remains below the $1.5550 level it is possible that we can see the Euro depreciate (dollar strengthen) by 3 to 5% over the next few months. Using the percentage change relationship in the table below a 3 to 5% strengthening of the dollar could lead to a 21.5 to 35.5% decline in the price of oil (as measured by Nymex spot WTI).
| Dollar/Euro Versus WTI Crude Oil | ||
| | 2008 to date | 2007 |
| | Gains | Gains |
| | | |
| WTI, $/bbl | $49.31 | $34.91 |
| Dollar/Euro | $0.1049 | $0.1354 |
| | | |
| WTI, % | 51.38% | 57.16% |
| Dol/Euro, % | 7.19% | 10.23% |
| | | |
| WTI % Change per | | |
| 1 % change in Dol/Euro | 7.15% | 5.59% |
| | | |
| Correlation Coefficient | 0.735 | 0.792 |
What do we expect this week? More of the same…above average volatility, possibly new all time highs in oil prices if the dollar does not start making some strong gains quickly and/or if this week’s EIA fundamental snapshot is bullish. Also let’s not forget the ongoing rhetoric going back and forth between Iran and the International community.
With a G-8 meeting underway in Japan today and lasting to the middle of the week we can expect to hear very strong words about high oil prices, reducing demand, drilling more, increasing utilization of alternative fuels, strong dollar, etc. All of which will likely impact volatility a bit more than the absolute price as most comments coming from the G-8 communiqué’s usually are very general with little impact on the short term movement of the markets. Finally the US equities markets begin the earnings season with most corporate earning expected to shrink for the 4 quarter in a row. We may see another week of equity selling around the world putting a cap on energy prices for the moment.
Stay buckled up and enjoy the ride.
Currently energy prices are lower for oil while the dollar is firmer.
| Current Expected Trading Range | | | ||
| | 7/7/08 | Change | Upper | Lower |
| | | From | Resistance | Support |
| | 8:00 AM | Yesterday | | |
| Aug WTI | $142.95 | ($2.34) | $150.00 | $130.00 |
| Aug HO | $4.0060 | ($0.1000) | $4.0000 | $2.7100 |
| Aug RBOB | $3.5238 | ($0.0472) | $3.7500 | $3.0000 |
| Aug NG | $13.355 | ($0.222) | $13.500 | $11.000 |
| | | | | |
| Euro/$ | 1.5597 | (0.0042) | 1.6000 | 1.5200 |
| Yen/$ | 0.9332 | (0.0077) | 1.0450 | 0.9000 |
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