Weak Dollar Limits Downside For Crude Oil

Over the last few month, the U.S. dollar index, after gaining ground to record highs immediately following the election, has been in a sustained decline since the end of last year, and is now at two and a half year lows. Some would have you believe that that is not a major influence on certain markets, particularly domestic energy markets such as WTI and natural gas, but they are, to put it simply, wrong.

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One of the biggest mistakes that those new to any market frequently make, is to become far too specific in their area of interest. If, for example, you decide that the energy markets are the most dynamic there are, with conflicting influences creating good two-way movement and therefore an opportunity for good trading profits I could not argue if you decided to concentrate your trading efforts there. Even if you get even more specific and restrict yourself to natural gas or oil futures trading, that is fine. If, however, in doing that you decide to ignore other markets you are making a mistake.

Traders in dealing rooms tend to have very specific areas of focus. I, for example, traded one currency pair in one time-period only, but when you see a picture of a trader at work they are always surrounded by screens. They have live price feeds and charts for a whole host of things other than those that they actually trade. But there are certain things that every trader, regardless of specialty, watches. The S&P 500, U.S. Treasury yields, and crude oil prices are on every trader’s radar, for example, along with some measure of the dollar’s strength. Some prefer the index and some prefer a few major currency pairs, but tracking the dollar one way or another is universal in a dealing room.

The reason is simple. The dollar is the base unit of currency in global economics, and therefore of value. Ultimately the price of most internationally traded things comes down to its value relative to the U.S. dollar. That is why those who would have you believe that because it is produced in the U.S. and sold in dollars at every stage, WTI, say, does not respond to fluctuations in the dollar are so wrong. In markets, intrinsic value is an important concept and those that make that argument obviously don’t understand it.

The dollar has an intrinsic value and anything that is priced in dollars responds to changes in that value. Regardless of where it is produced, sold or consumed, crude oil is one of those things. If the dollar is intrinsically worth less, then anything traded against it is worth more of them.

That doesn’t mean that the relationship is immediate or tick for tick. Fundamental supply and demand are the bases of pricing for oil or any commodity, and the short-term nature of oil futures trading make technical factors extremely significant. Changes in those factors will always override the influence of the dollar. That, however, doesn’t mean there isn’t one. It is just that it tends to be limiting rather than directional.

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So, with the dollar at record lows, it would be foolish to pretend that there is no effect on WTI. It is the reason why, despite ever expanding production under a friendly White House administration adding to an already record global glut of crude, we are once again hovering around the $50/barrel level. It is, at least in part, why we have been in an upward pattern since mid-June and why every break lower over the last few weeks has quickly stalled. Ultimately, it may not drive us higher without other stimuli, but at the very least it limits the downside.

In short, therefore, yes you should care that the dollar is low. In fact, you would be crazy not to.