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Schork Oil Outlook: Don't Bother Tracking US Dollar

Dollar no longer short-term indicator for crude

In the two weeks leading up to the Fed’s decision in early November to commence with QE2, Nymex crude oil for January 2011 delivery rallied 7.8% from $80.88 to $87.16 and the U.S. dollar fell 3.4% against the euro, from €0.7285 to €0.7039; all on the assumption that the Fed’s actions, which are intended to spur inflation, would be bearish for the dollar and bullish for commodities.

Over this time-step the correlation coefficient (60-day) was a very solid -0.927 (-1 is perfect negative correlation). In other words, as went the dollar, so went oil… in the opposite direction.

However, since the Fed announced its plan to purchase another $600 billion of U.S. government debt ($100 billion above the market consensus) the dollar has jumped by 6.1% against the euro, €0.7468, but crude oil has rallied (!) by 2½%. What’s more, volatility in the interim has been acute. For instance, over the six sessions in between the 10th and 17th of November the January contract plunged by 7.7% to $81.04 and the dollar rallied by 1.9%. The market has since bounced back by 9.1%, but the dollar has rallied by another 1.04%.

As such, short-run correlation has morphed from a virtual inverse lock-step relationship of -0.927 to positive (!) 0.0397. Thus, for the time being the dollar is a poor tool for trading decisions in the short-run (days).

Be that as it may, from a longer term perspective the dollar’s path is still one of the best indicators of oil’s direction. As discussed in today’s issue of The Schork Report, for the 519 weeks since the start of the decade the relationship between oil and the dollar has been inverted twice as many times. That is to say, over 519 weeks oil and the dollar have moved in tandem 157 weeks with an average coefficient of 0.332. On the other hand, the two asset classes have moved inversely in 362 weeks with an average coefficient of -0.607.

In this vein, as of last week the 52-week correlation was -0.457. This inverse relationship has increased steadily since the summer. Therefore, if you can tell us where the dollar will be one year hence, we are confident we can tell you where crude oil will be. Short of that we will just have to take this market one day at a time.

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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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