From the March 2014 issue of Futures Magazine • Subscribe!

Trading crude with stocks and time

Among the world’s commodities, crude oil is one of the most visible and relevant to individual consumers. This is because each time we purchase gasoline for our vehicles, we perceive the price of crude oil reflected in the price we pay for gas.

Historically, high gasoline prices were viewed as being inflationary. There most certainly is a measure of truth to this. However, based partially on the lack of a value-added tax (VAT) in the United States, as well as other structural factors, U.S. drivers pay a much lower fuel tax than drivers in other nations. Consider Norway and Italy, where fuel regularly costs more than $9 a gallon rather than the $3-$3.50 paid at the pump in the United States today. An argument also could be made that the lack of this tax structure allows crude oil prices to have a more direct impact on the U.S. retail gasoline market.

In addition to price, consumers also are exposed to crude oil volatility. Price increases are reflected at local gasoline stations almost immediately. Who can’t recall 2008 when the per-barrel price of crude rose to $150?

Price drivers

Foreign exchange relationships are a major factor in the price of crude. Crude oil and the U.S. dollar generally have an inverse relationship with one another, meaning that if the dollar drops, then the price of crude increases, and when the dollar rises, the price of crude oil should fall.

However, as with many economic relationships, this is not always the case. The dollar is driven by many factors, including the threat of government shutdowns, the extent of Federal Reserve tapering, economic trends in other countries, trade balance, etc. Forex is a true global market, with fluctuations of other major currencies such as the euro, yen, etc., having a direct effect on the value of the dollar.

Consider March 2013 when Mario Draghi, president of the European Central Bank (ECB), made a comment about the euro that was taken out of context. 

“We aren’t concerned about the value of the euro,” he said, referring to inflationary pressures.

Instead, the market had another interpretation. The euro dropped like a rock, the dollar took off and dollar-priced markets found themselves under enormous pressure.

So the question remains: If we cannot rely on the dollar as a correlated asset for crude, what can we rely on? If crude is supposed to be a bellwether in terms of economic growth, then why not tie crude to the E-mini Dow (YM) contract? If YM is increasing in value, then it makes sense that crude futures (CL) should follow suit. If crude increases in value, it is evidence of a stronger economy. Considering a strong economy tends to reveal itself first in stocks, then equities may indeed lead crude — or at least the two should move in tandem.

One fundamental trend that might affect this relationship going forward is the adoption of hybrid vehicles. At this time, however, electric vehicles have not yet fallen in price to the point where it’s economically feasible for the average citizen to purchase one. At $60,000, a four-door Tesla sedan is not ready to supplant cheaper gasoline alternatives for most Americans. And ultimately, these vehicles run on the energy source the electric utilities use, which to a great extent is still fossil fuels.

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