The Death of the Dollar and Oil’s Inverse Relationship
Commodities and the dollar are supposed to have an inverse relationship.
But this chart doesn’t show that…
In fact, I believe it shows an emerging trend: We may be watching the death of a relationship that analysts and investors have followed closely for many years.
The U.S. has changed so much that we may have to consider the old pattern broken.
So far this year, the price of crude and the U.S. dollar have fallen in tandem…
Since things like crude, gold and other resources are often priced in dollars, when the greenback falls, commodities rise. A weaker dollar simply means it takes more dollars than before to purchase the same amount of a commodity.
And the inverse is true. When the dollar strengthens, commodities fall because it takes fewer dollars to purchase those same commodities.
But the crude-dollar relationship is one of the most followed and cited correlations.
A study by the European Central Bank found that for every 1% decline in the dollar’s value, crude averaged a 0.73% move higher.
So it’s not a perfect 1-1 ratio.
In 2016, we saw crude move inversely to the dollar. But both rallied in the final month of the year – crude on the announcement of OPEC production cuts and the dollar on the results of the U.S. presidential election.
This year, the dollar is down a little more than 5%. But crude has fallen more than three times that.
Since 2000, we’ve seen the dollar and crude move inversely. And the fundamentals at play have exacerbated the effects.
Crude became a truly global commodity.
For example, from its high in February 2002 to its low in March 2008, the dollar lost a third of its value. During that same time frame, the price of crude rose fourfold.
China’s surging demand for all things really goosed this rally. Global supplies were tight then. There was no “shale revolution.”
From 2000 to 2007, global oil demand rose 12.7%. Supply lagged, rising just 9.6%.
The weaker dollar helped drive that demand, driving the market fundamentals at play even further.
Then from March 2008 to March 2009, the global economy collapsed. Demand around the world buckled, and crude fell.
The price of crude fell 60%, and the dollar rose 18% – but not on strength. It’s just that every other currency was even worse.
Today, the market is in transition… and the inverse relationship we’ve come to expect from oil prices and the dollar is changing.
When It Rains, It Pours
Dan Dicker, president of MercBloc LLC and oil market strategist, recently summed it up best: In a bear market, all news is bad news.
That’s the nightmare crude’s been living.
Last year, crude enjoyed an exceptional run, with prices doubling from its lows.
It’s been a very different story in 2017. Bullish news for oil has resulted in price declines – and in some cases, outright collapses.
First, OPEC and its partners decided to extend oil production cuts of 1.8 million barrels per day for another nine months. And yet, the price of crude fell.
The market said, “It’s not enough.”
Then Saudi Arabia and the United Arab Emirates cut diplomatic ties with Qatar. After an initial bump higher – because commodities rally on political uncertainty – the price of crude fell.
The reason? The production cuts that were extended for nine months could be disrupted.
So right now we’re not only seeing the market continue to struggle with the demand-supply picture, but we’re also witnessing the dollar-crude relationship unravel.
Both are because of U.S. shale production.
The dollar-crude relationship was tied to U.S. crude imports.
For more than a decade, oil imports have been falling. Net crude imports are down 30% from where they were the week of June 10, 2005.
At the same time, the shale revolution was born. Today, it’s running full throttle. U.S. shale production is at record highs.
All of this has been devastating for the oil sector. But it’s created a notable divergence in performance among oil-related ETFs since the start of 2016. It’s something investors should be aware of…
Year to date, the SPDR S&P Oil and Gas Exploration and Production ETF (NYSE: XOP) is down more than 22%. Its losses are larger than those of the United States Oil Fund ETF (NYSE: USO) or the Alerian MLP ETF (NYSE: AMLP).
Companies held in the Oil and Gas E&P ETF are flooding the market with oil. And their shares are being hammered in return.
But if we look at how those ETFs have performed since the start of 2016, we see the Oil and Gas E&P ETF is roughly 6% higher from where it began 2016… yet the price of crude is 21% higher since then.
We also see that the Oil and Gas E&P ETF never really outpaced crude to the upside. And it has seen a much sharper decline in 2017.
In that same span of time, the Alerian MLP ETF, which includes companies involved in the storage and transportation of oil, is down almost 5%. Pipelines are often seen as safe havens in the crude markets because they’re supposed to make money, regardless of crude’s price.
Plus, the dividend payments are there to entice investors through thick and thin. Admittedly, even though it has lagged crude over the past 18 months, the Alerian MLP is down only 9% year to date – and that’s the top performer of the four.
Meanwhile, the U.S. Oil Fund ETF has fallen 16% since the start of 2016. Year to date, it’s down more than 21%. This demonstrates that the fund isn’t a great proxy for crude since it’s based on futures contracts.
The crude market is undergoing a transition. As I wrote last week, U.S. producers are emerging as the most influential players in the world.
And I believe this will continue to unwind crude’s inverse relationship with the dollar.