Despite strong fundamentals and the fact that we are losing 400,000 gallons (we think) of crude oil every day in the Gulf Coast, traders have been pushing the liquids lower on the back of the almighty dollar. It was exactly two weeks ago today that crude oil prices peaked at $86.19. Since then they have fallen 18.7% to $70.08 as of last night. Meanwhile the dollar has rallied 6.4% from €0.758 to €0.807 over the same period.
As today’s Chart of the Day in today’s issue of The Schork Reportillustrates, the correlation coefficient between the two securities has strengthened to - 0.64, which means that 64.3% of crude oil’s drop can be explained by the strength in the dollar (and vice versa).
But as the chart also shows, this was not always the case. As close as April 13th, the correlation co-efficient stood at a positive 0.620, i.e. 62.0% of crude oil’s rise could be explained by strength in the dollar! In fact, historically the correlation varies from highs of 0.888 to lows of - 0.971.
So what causes this wide range? Intuitively we expect the relationship to be negative — crude is a dollar denominated currency, so a strong dollar makes crude oil more expensive in terms of other currencies. To counteract this drop in demand, the price of crude oil falls, returning demand to its equilibrium value. In theory.
- Crude (Brent & Nymex), NatGas and RBOB Futures
In reality, we have seen large spreads of time where the dollar and crude rise or fall in tandem. Between May and June 2008 the correlation averaged 0.233. Between late December 2008 and February 2009 correlation averaged a positive 0.458. Both periods marked a gain in both the dollar and crude oil as speculators fuelled the market higher. Correlation returned to an inverse relationship after the highlighted periods, the difference is that in July 2008 it was crude that fell while the dollar rose, whereas in March 2009 it was crude oil which rose while the dollar fell.