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Ca$h Money: The Price of Oil and the U. S. Dollar

This article continues our examination of the various factors that influence the price of oil. A second key indicator of the oil and gas market’s price direction is the value of the U. S. Dollar and the strength of that currency’s directional trend.

Inverse Relationship

Commodities like oil, gold, soybeans, etc., are valued in U. S. Dollars regardless of their location of production. Middle Eastern crude, Asian soybeans, and South American wheat are all valued in U. S. Dollars because the U. S. economy is perceived to be the strongest and most stable economy in the world. Generally, when the value of the U. S. Dollar falls, the price of commodities rise. This inverse relationship is most pronounced when the U. S. Dollar is in a strong bull (rising) market or strong bear (falling) market; the greater the trend strength, the greater the correlation (x marks the spot).

This inverse relationship can be seen on the following 25-year chart. The chart clearly shows Crude’s turnaround from the doldrums of the 1990’s as the U. S. Dollar peaked in early 2002. Crude, then went on an incredible bull run to its peak in the middle of 2008, just as the U. S. Dollar hit a decade low, making an X on the chart in 2005, the telltale sign of an inverse relationship.

WTI_25_YR

(U.S. Dollar = Green; Crude = Black)

The chart also shows that the U. S. Dollar and Crude generally trended upwards from early 2009 until the middle of June 2014. The U. S. Dollar then went on a tear from approximately $80 to top at $100.715 several months later. Crude prices dropped precipitously during this time. As in the earlier run from 2002 to 2008, X marks the spot.

For average investors who are unable to weather the extreme volatility of the futures market, examination of this inverse relationship can provide guidance on which alternative investment vehicles to pursue. An easy way to benefit from these moves is to purchase shares of Electronically Traded Funds (ETF’s) that track the price of Crude. There are inverse Crude ETF’s to benefit from bear markets and X2 or X3, etc. leveraged ETF’s that magnify bull or bear price movements. Additionally, there are a few ETF’s that track the price of the U. S. Dollar, though none yet that are inverse or leveraged. Note that when investing in ETF’s it’s a good idea to keep an eye on contango vs. backwardation in the futures market, a topic for a subsequent article.