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Friday, May 22, 2009

Oil Spike a Result of Dollar Weakness? Not Necessarily

In my post about the run up in the price of oil, I received the following comment:

Dollar weakness was left out of all of those explanations. Since the quantitative easing program hit high gear around March 19th, the price geometry has been constructive (minus one correction mid-rally -- few, if any rallies go straight up). Graph the dollar index or euro-dollar trade against a crude oil chart. You will see significant pressure of late due to concerns of firming inflation on the forward curve.
Since March 19th the Euro is up "only" 1.7% against the dollar (all of which took place the last two days). And while I do agree that a strong or weak dollar can and will impact the price of oil over the long run, I don't necessarily buy it as a reason in the short run. One reason, if the oil rally were due to a decline in the dollar, oil wouldn't have outperformed a "better" store of value (i.e. gold) over that same time frame.

Gold / Oil Ratio; May 2006 Index = 1

In looking at the chart above, we see the two were extremely correlated until the global economy blew up last Fall and gold outperformed by a factor of 4. Oil has shown a strong comeback since that time. And since that March 19th quantitative easing date?
  • Oil is up 10%
  • Gold is flat
What I do find as an intriguing theory is that in "uber-real" terms (i.e. the price of gold), oil overshot to the downside. Thus, while oil has rallied rather significantly over the past three months, it is just mean reversion from this oversold territory.

*Note the above chart is inexact as it uses the ETF's
GLD and USO as representatives for gold and oil respectively (I am working from home ahead of the long holiday weekend - i.e. no Bloomberg).

Could this be another reason?