Dollar-Neutral Crude Oil
Adam Hamilton
Crude oil is one of the hottest commodities on the planet
these days. Almost without respite, it
has surged 16% in April alone! It closed
at new all-time record highs on 8 of the past 11 trading days. Pushing $120 per barrel now, the fabled $100
price point that the markets feared for so many years now seems modest.
Commodities bulls have been long oil and oil stocks for many
years now, so oil’s strength isn’t too surprising. Naturally we attribute its powerful advance
to a global supply and demand imbalance.
Oil demand is simply growing a lot faster than oil supply, so higher
prices are the only way to retard demand and accelerate production until a new equilibrium
price is reached.
But Wall Street, with its perpetual anti-commodities bias,
continues to try and dance around the ironclad fundamental basis for this oil
bull. In sectors it doesn’t like, it
tries to rationalize away fundamentals in order to attribute advances to more
ephemeral factors. So now it claims
speculators and the US dollar are almost exclusively driving oil.
If speculators are to blame, oil should have witnessed a
sharp correction after it hit the most overbought levels of
its entire bull in early November. Yet
instead of plunging from the high $90s, oil merely consolidated sideways at
these high levels. It formed a base
between $87 and $100 from which its latest rally launched. Speculative fervor is short-lived, it alone
cannot maintain record prices for 6
months running.
Speculators buy in fast, driving vertical moves. And they leave even faster, sparking sharp
plunges from highs. The latter didn’t
happen in oil, suggesting a global supply-and-demand imbalance is a far larger
factor driving its extraordinary strength over the past 8 months than
speculator greed. So Wall Street’s
latest avoidance strategy is to blame the dollar, claiming oil’s strength is mainly
the result of a weak dollar.
Today in mainstream market analysis, it is increasingly rare
to see oil mentioned without the struggling US dollar being credited for oil’s
strength in the very next sentence.
While the weak dollar is definitely a factor, overemphasizing its role
is misleading traders. If traders
believe the Wall Street party line, then they expect oil’s strength to fade
whenever the dollar rallies. This could
really adversely affect their future gains.
If fundamentals are oil’s primary driver, its bull market
will persist for many years to come until some sort of new equilibrium
consumption and production level is reached that fully reflects the ascent of
Asia. But if the dollar is oil’s primary
driver, then its bull is largely over as soon as this dollar bear ends. Obviously prudent investment strategies going
forward would vary considerably between these two different worldviews.
So as a long-term investor in energy stocks, I wanted to
gain a better understanding of just how big the US dollar’s role has been in
oil’s bull. With the Fed actively trying to destroy
the dollar’s international purchasing power, everything we import into the
States has to become more
expensive. So the dollar is definitely a
factor. But real fundamental oil imbalances
exist too, so the dollar certainly isn’t the only factor.
To do this research, I wanted to render oil in
dollar-neutral terms. What would this
oil bull look like if the ongoing US dollar bear was somehow extracted out of
oil prices? I thought about doing this
mathematically, creating a hypothetical oil price based on a flat US Dollar
Index. But such a construct doesn’t
reflect anything relevant in the real world.
So instead I charted oil in key alternate currencies.
The first is the euro, the leading contender to usurp the
dollar’s long reign as the world’s reserve currency. Across the globe, everyone from central banks
to street vendors happily accepts euros.
As an added bonus, the euro now dominates the benchmark 35-year-old USDX. The euro accounts for 57.6% of this index’s
entire weight today! The Japanese yen is
a distant second at just 13.6%. Thus
looking at oil priced in euros is essentially USDX-neutral because the euro is the USDX.
The second alternate currency is the world’s oldest and
best, gold. Gold maintains its intrinsic
value over centuries regardless of what central banks are doing to debase their
own fragile fiat currencies. Gold is
also highly sought-after by the major oil-exporting countries, so they almost
certainly monitor oil priced in gold to see what kind of real value they are
getting for their scarce depleting resource.
Oil priced in gold is fiat-currency neutral.
On these charts, oil priced in euros and gold with the usual
accompanying technicals are rendered on the right axes. Underneath this, the familiar US dollar oil
price is rendered in red and tied to the left axes. At 5 major bull highs in USD oil, oil’s
bull-to-date gains in both the alternate currency and US dollars are noted,
along with their ratio. All axes are
zeroed to ensure the relative slopes are visually distortion-free.
Oil is also making new all-time highs in euros today, but
they aren’t anywhere near as extreme as those in dollars. Between the major USD oil highs in July 2006
(number 4 above) and today, USD oil has rallied 53.5%. But euro oil’s simultaneous top-to-top gain
is a far-more-modest 22.1%. This yields
a ratio of 0.41x, suggesting that just four-tenths of oil’s USD gains since
July 2006 were driven by global fundamentals.
But realize this was over an exceptionally weak period
even for this dollar bear, so we shouldn’t jump to conclusions from one
comparison. Instead it’s best to start
at the beginning. Back in November 2001,
oil bottomed under $18 and kicked off our current secular bull run. The USDX was near secular highs then,
challenging 120, so oil was relatively cheap for the US. The parallel bottom was much higher in euro
terms, just under €20.
But as the US dollar bear started in earnest in early 2002,
dollar oil began to rise faster than euro oil.
By the time oil reached its first major bull high in March 2003 in the
pre-Iraq-invasion spike, euro oil was only up 0.65x as far as dollar oil’s
117%. Euro oil’s initial uptrend was
more modest too, nowhere near as steep as dollar oil’s. And as euro oil’s 200dma shows, it was
essentially flat from 2002 to mid-2004 during the worst years of the US dollar
bear. Back then oil was a dollar thing!
Euro oil’s current uptrend began from these humble basing
roots. By oil’s second major USD high in
October 2004, euro oil was only running at 0.56x the USD oil’s gains. In 2005, the USDX surged in a massive bear
rally for the better part of an entire year.
During this rally euro oil shot up far faster than dollar oil. By oil’s third major high of this bull in
August 2005, euro oil was up 0.63x as far as USD oil’s 300% gain.
During much of 2005 and 2006, euro oil gradually climbed in
a high consolidation. Back then oil
looked relatively stronger in dollar-neutral terms than it did for the US
markets. To the rest of the world, this
is what high oil prices looked like until late 2007. We are talking about €55 per barrel or
so. So oil’s new highs today don’t look
quite as extreme outside of the dollar world as they do to Americans.
Dollar-neutral oil also fell farther in the sharp 2006 oil
correction than USD oil. But
interestingly euro oil still largely remained within the wide uptrend it
established in 2004 and 2005 while USD oil plunged way below its own uptrend’s
support. And euro oil’s big upleg since
the resulting January 2007 lows remained within this uptrend until just the past
couple weeks when it shot north of €70 per barrel.
Overall, oil in euros is up 276% in its bull to date versus
dollar oil’s massive 577% gains. This
works out to a ratio of 0.48x. So from
this perspective, it looks like about
half of oil’s total bull gains are fundamentally driven while the other
half are dollar-bear driven. The dollar
bear deserves more credit than I originally suspected!
Incidentally the USDX is down 41% at worst in its bear to
date while the euro is up 91% over this same time frame. With the dollar nearly being cut in half and
the euro nearly doubling, the 0.48x ratio between euro-oil and dollar-oil gains
makes sense. Nevertheless, a 276%
dollar-neutral gain in the world’s most important commodity is nothing to
sneeze at. Fundamentals are definitely driving this global secular
oil bull.
While the euro is likely to be the next world reserve
currency, it is still just another hopelessly flawed fiat-paper currency. Some would argue it is the worst kind of fiat
too, as it is a composite currency of many countries that have long loved invading
each other. Can many sovereign nations
with differing economic challenges and objectives hold the fragile euro
together for decades to come? Only time
will tell.
To truly see fiat-currency-neutral
oil prices, we have to look at oil priced in gold. It is probably the best-available global
representation of the rising real
price of oil in its bull market. To see
the world’s most important commodity charted in terms of the world’s only
currency with universal intrinsic value is striking. Although I have watched the gold/oil ratio for many years
now, this chart still stunned me this week.
In gold terms, oil is only up 107% in its bull to date! And in a world teeming with fiat currencies
backed by nothing but faith in politicians not screwing things up too badly,
gold may be the only real standard of value left. Gold oil is up just 0.19x USD oil’s 577%
gain. While the real value of oil in
terms of gold has still more than doubled, this is a far cry from the massive
oil gains we have seen in US dollars.
Gold oil’s uptrend reflects this with a far-more-modest
upslope than fiat-currency oil. At oil’s
cheapest in January 2002, it only took 0.063 ounces of gold to buy a barrel of
oil. This made gold oil’s secular low
much higher than dollar oil’s as this
dual zeroed-axis chart clearly shows.
Incidentally, gold was only trading at $285 per ounce back then while
oil was just under $18. How times have
changed!
Like euro oil, gold oil was largely flat from 2002 to mid-2004. It ground sideways for the most part as its
200dma reveals. Nevertheless, some rare
extremes helped define a support line that has held to this very day and an
initial resistance line that gold oil just happened to hit again this week. Later oil spikes would start to define a
second higher resistance line, but the original remains the one repelling gold
oil the most.
Interestingly, until mid-2005 gold oil tracked euro oil pretty
well. At dollar oil’s first three major
bull highs, gold oil’s ratio to dollar oil’s gains ran 0.63x, 0.49x, and
0.52x. This isn’t all that different
from euro oil’s parallel ratios of 0.65x, 0.56x, and 0.63x. Prior to mid-2005, gold was in a Stage One bull driven by
the dollar bear, so this makes sense.
Since mid-2005, gold has decoupled from the dollar and is now driven by
global investment demand in Stage
Two. So gold’s gains have
far-outpaced the dollar’s losses since.
Oil priced in gold reached its peak in late August 2005, at
0.162 ounces per barrel. Provocatively
this is far higher than gold oil today!
So relative to gold, oil has been getting less valuable since then.
This sure paints a different picture of this oil bull than viewing it in
fiat currencies does! That 2005 price
spike was an anomaly, as it was driven by hurricane Katrina ripping through US
oilfields. Nevertheless, today gold oil
is still not extreme relative to recent history.
Oil priced in gold, of course, is the inverse of the classic
gold/oil ratio. While long-term GOR analysis is very
interesting, there is a major criticism against it. Why should the ratio between gold, almost all
of which that has ever been mined in world history still exists, and oil, which
is burned immediately upon production and forever lost, remain in a constant
range? This is a great question that
plagues multi-decade GOR studies.
But over the short term, this question is a lot less
relevant. There isn’t much more gold
around now, in terms of world supply percentage growth, than there was 5 years
ago. So the gold oil price trend is far
more likely to be relevant over years than decades. Since gold oil has largely remained in its
current uptrend for over 6 years now, odds are this trend remains in force
today.
Obviously this has big implications for traders. Today gold oil is at its lower-resistance
line, the point at which oil has usually retreated in gold terms. The only way gold oil can retreat today is if
dollar oil falls, dollar gold rises, or some combination of these two
transpires. Since oil is widely loved by
speculators and overbought today while gold is increasingly despised and
oversold, I suspect it will indeed be a combination.
In secular bulls, a price’s 200-day moving average is its
highest probability support zone to bounce at in a correction. So if oil corrects, its 200dma which is now
at $90 (€62) is a logical downside target.
If gold oil falls to its bull support, which has yet to be materially
violated, we’d be looking at 0.09 ounces of gold to buy a barrel of crude
oil. At $90 oil this yields a gold
target of $1000 per ounce, higher than today’s levels.
Of course there are many other oil-price and gold-price
scenarios that would keep gold oil traveling within its well-established bull
uptrend. But most involve high or rising
gold prices relative to recent history. While
I can’t prove it, over the years I’ve seen plenty of anecdotal reports
indicating major oil producers watch oil pricing in gold. It gives them a solid metric for their depleting
resources independent of other countries’ fiat-currency manipulations.
Back to the task at hand, the modest uptrend of gold oil has
many implications. Oil in gold terms has
still more than doubled so a secular fundamentally-driven currency-neutral oil
bull absolutely exists. Yet a 107% real
bull run over 6+ years is pretty modest.
We are talking about a compound annual gain of just 12.3% here. This makes oil’s bull look much more
reasonable and much more sustainable than its dollar rendering implies.
This heretical view challenges a lot of widespread
assumptions. Wall Street loves to throw
around the word “parabolic” when it describes oil, yet oil hasn’t even come
close yet even in dollar terms. Going parabolic
is many consecutive days of 4%+ daily
gains, rare climax-stage events. And
when viewed in gold, oil’s secular upslope remains so modest that technically
it looks like we are at least a decade away from true parabolic oil gains.
Politicians love to demagogue on high oil prices while
consumers love to whine about them. But
in real terms, oil is a lot cheaper today than it was in the summer of
2005! It is too bad the US Congress and
American people will never understand this.
We are all trapped in viewing the world through the lenses of our own
fiat currencies, but as our central banks debase them it radically distorts our
perceptions of real price trends.
So dollar-neutral oil is pretty interesting. In some ways it is great as it proves this
oil bull is a global supply-and-demand driven beast totally independent of
currencies. It shatters Wall Street’s
oft-advanced thesis of late that oil is only rising because the US dollar is
weak. Nonsense! On the other hand though, the
perpetually-inflating fiat currencies are having a bigger impact on oil’s
nominal prices than I expected.
When viewed in euro terms, it looks like about one-half of
oil’s dollar bull is fundamental. But
when viewed in gold terms, this fraction drops to merely one-fifth. This is somewhat disturbing as it calls into
question all kinds of perceptions about nominal price moves in all assets
worldwide. Perhaps everyone, even
students of monetary theory, is seriously underestimating the impact of fiat
inflation on asset prices.
Even if our currency measuring sticks are this hopelessly
flawed, there is no doubt commodities and commodities stocks have been rising
much faster than any other major asset class in recent years. This makes them the premier destinations for
investment and speculation capital. At
Zeal, we have been investing and speculating in commodities stocks since these bulls began in
the early 2000s.
And due to the persistent global structural deficits in
producing many commodities, these secular trends are likely to continue. World production can’t even hope to keep pace
with surging emerging-market demand as Asia industrializes. If you want cutting-edge analysis on key
commodities and their producers, subscribe
today to our acclaimed monthly
newsletter. We are constantly
analyzing the world scene to look for high-potential-for-success trades in
elite commodities stocks for our subscribers.
The bottom line is this oil bull that Americans are
marveling over looks a lot less impressive in dollar-neutral terms. Rendered in euros, it looks like the dollar
bear could be responsible for half of oil’s total gains. But rendered in gold, this number could jump
to four-fifths! Either way, the dollar
bear is still not the whole story as Wall Street suggests. Global oil supplies are simply growing too
slow relative to worldwide demand.
And considered in alternate currencies, oil does not look
anywhere near as overbought as it does on dollar charts. This increases the odds that we’ll see continuing
high consolidations in oil in dollar terms, not the sharp plunge many
mainstream traders are hoping for and betting on.
Adam Hamilton, CPA
April 25, 2008
So how can you profit from this information? We publish an acclaimed monthly newsletter, Zeal Intelligence, that
details exactly what we are doing in terms of actual stock and options trading
based on all the lessons we have learned in our market research. Please consider joining us each month for
tactical trading details and more in our premium Zeal Intelligence service at …
www.zealllc.com/subscribe.htm
Questions for Adam?
I would be more than happy to address them through my private consulting
business. Please visit www.zealllc.com/adam.htm for more
information.
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually
increasing e-mail load, I regret that I am not able to respond to comments
personally. I will read all messages
though and really appreciate your feedback!
Copyright 2000 - 2008 Zeal Research (www.ZealLLC.com)
Email this Article to a Friend 
Printer Friendly Version