Oil regains upward trend as dollar plummets

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“You cannot find peace by avoiding life.”

Virginia Woolf

After starting Tuesday's session in negative territory oil prices staged a reversal rally and ended the day with modest gains. The recovery has continued in overnight trading pushing prices well above the $107/bbl (basis WTI) support level and signaling that oil is still trading within the uptrend it has been in prior to Monday's sell-off. In fact, as of this writing the spot WTI contract is within $0.50/bbl of recovering all of Monday's losses. Just about every indicator/price driver that was pointing to lower oil prices earlier in the week all reversed and are now supporting firmer prices. Recall in yesterday's newsletter I warned that selling could end very quickly...if the financial markets turn around coupled with the fact that this is a shortened trading week with most markets closed on Friday. Well that is pretty much what happened yesterday and the turnaround in financial markets, especially equities, has continued through Asian and European trading hours so far. Looking back at Monday's trading activity we can now begin to categorize it as an overreaction to the S&P downgrade as the market has now pretty much discounted the news.

Further support is coming from the global equity markets and the US dollar which has plummeted over the last several days. The US Dollar Index (USD against a basket of six major currencies) has now solidly breached this year's low and is quickly approaching the lows made back in December of 2009. The falling dollar is very supportive for oil prices as well as the broader commodity complex. The following chart highlights the relationship between what I call the big three...oil, equities and the US dollar. In spite of all of the events that have been driving oil prices, the correlation between equities and oil has remained in place as has the inverse correlation between the direction of the US dollar and oil prices. As shown on the chart the dominant relationship that has been in play and continues to be in play is the inverse relationship between the US dollar Index and WTI & Brent. For now we have to respect this relationship and as long as the US dollar continues to head lower we can expect oil prices to advance or at least remain firm at a minimum.

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