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Schork Oil Outlook: Stocks vs Dollar—Reading Patterns

Tuesday, 14 Sep 2010 | 10:00 AM ET

Dollar’s global reach is key to the race to $100 oil.

Traders and analysts are a smart bunch, but their tool box has two key items: patterns and correlations.

With patterns, if prices reacted a certain way in the past, we like to assume they will act that way going forward. Similarly, if we conclude that two series are correlated, we can assume the movements of one are based upon the other.

For crude oil, these correlations come with the dollar, which has an inverse (negative) relationship, and equities which have a positive relationship. However, yesterday the dollar fell by 1.53%, while equities rose 1.11 %.

Crude rose, i.e., its correlation with equities mattered more than its correlation to the dollar. Will this pattern repeat?

In the short term: yes; in the mid-term, no. To quantify correlation, 1 implies perfect correlation (prices move in the same direction), -1 implies perfect negative correlation (prices move in opposite directions) and 0 implies no correlation (prices move independently).

WTI's correlation with the S&P 500 index is off its recent high of 0.8052, when equities and crude oil fell in lockstep with a spate of weak economic releases, but remains strong at 0.7591. On the other hand, correlation with the dollar is stronger than the -0.4267 seen in July, but remains mild at -0.5441.

Since traders are still unsure of the consumer’s health, today’s retail sales numbers will likely push crude and the equities in roughly equal measure. However, once the recovery is on track and consumer health is established, traders will likely lose interest in minutiae movements in the equities.

Hamza Khan, analyst at The Schork Report, avers that the dollar’s global reach — and its influence on OPEC decisions — will become increasingly important in the race to $100.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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