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Most investors believe that the U.S. dollar is the primary influence upon commodity prices. While there certainly is a strong correlation between the dollar and commodities, we would argue that the real dynamics in the market work slightly differently.
Example: Oil has the potential to set the dollar price, which in turn puts pressure on the broader commodity complex. Has the world turned upside down? Please bear with us as we explain our view.
There is an almost perfect negative correlation between crude oil and the U.S. dollar. Consequently, crude oil has a strong positive correlation with the euro. The next two charts show those relationships.
Crude Oil (red) versus EUR (black)
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Crude Oil (red) versus USD (black)
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Examine the oil/currency correlation. Crude oil is one of the largest markets with an annual value of $1.7 trillion so its moves strongly influence other markets. As the price of crude oil drops, there are fewer dollars in circulation. Consequently, the dollar price rises, and the euro falls.
Moreover, it appears that oil exporting countries (think Saudi Arabia or Iran) trade oil in dollars but they invest part of their reserves in euros, according to Robert Gabriel Luta. When the oil price falls, their revenues decline, and they transfer fewer reserves from dollars into euros.
Recently, Saudi Oil Minister Ali Al-Naimi said, “no one can set the price of oil – it’s up to Allah.†(source: Zerohedge)
One of the most influential individuals in the oil market worldwide probably knows better. What is really occurring?
The next chart says it all. The global oil supply and demand picture shows that OPEC increased oil production last September for the first time in more than 1.5 years, as marked with the green circle. Until that time OPEC was consistently reducing their oil production 0.5 to 1 million barrels per day.
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Was it coincidence that the oil price began to crash exactly one month before? No, and it was not Allah, as suggested by Mr. Al-Naimi. Some market participants knew more at the time.
