How logical is the link between oil and the dollar? - Yahoo!

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How logical is the link between oil and the dollar?

On Tuesday 19 July 2011, 12:57 PM

By Nia Williams and Barbara Lewis LONDON (Reuters) - At the end of this week, the International Energy Agency (IEA) is expected to announce the results of its 30-day review of an emergency reserves release, which shocked oil markets and sent ripples across foreign exchange. Some countries are said to be opposed or at least reluctant to agree to further action for now, but there could still be another release at some point this year. In addition, the United States, which accounted for half of the 60 million-barrel oil injection announced on June 23, could add more oil to international markets from its strategic reserves regardless of what the IEA as a whole decides. The release from emergency stockpiles was only the third in the 37-year history of the IEA, and the announcement last month initially prompted a 6 percent sell-off on the oil market. On the currency markets, the dollar index rose 0.9 percent on the day, exaggerating the negative correlation that typically characterises the relationship between oil and the U.S. currency. Oil prices have since recovered, with Brent crude futures trading above $116 per barrel, versus just over $114 before the reserves release. The following looks at some of the questions surrounding the influence of currency markets on oil and vice versa. HOW STRONG IS THE NEGATIVE CORRELATION? The negative correlation with the dollar was particularly sustained for much of 2009 as the world began to emerge from deep recession and economic stimulus provided a wave of cheap money. That weakened the U.S. dollar but drove a wave of buying across other assets, notably dollar-denominated commodities such as oil, which became relatively cheap to holders of currencies other than the dollar. A weak dollar can also provide a motive for the Organization of the Petroleum Exporting Countries to seek a higher oil price as it seeks to protect its dollar income. A second round of U.S. quantitative easing (QE2) helped to spur a sustained oil market rally, which began in the final quarter of last year and gained added momentum this year after Libyan output was shut in by civil war. Federal Reserve Chairman Ben Bernanke has canvassed the idea of further QE should economic growth and inflation slow, comments that could add to dollar weakness. The negative correlation with oil could be curbed, however, by sentiment on oil markets that high prices are denting demand, especially in the United States, the world's largest oil consumer and the largest -- but fragile -- economy. The 66-day rolling correlation between U.S. crude and the dollar index, a measure of the dollar's performance against a basket of currencies, was at minus 0.50 on Monday. The negative correlation narrowed sharply to minus 0.09 in March when the earthquake and tsunami in Japan prompted huge repatriation flows from the dollar into the yen, while oil prices fell in a wave of risk aversion across asset classes. DOES THE DOLLAR INFLUENCE OIL OR THE OTHER WAY ROUND? In a medium-term report earlier this year, the IEA cited econometric techniques that suggested causality might run from the oil price to the exchange rate, rather than the other way round. "When the price of an import rises, if the demand for that import is very inelastic (i.e. quantities demanded hardly fall at all when the price is increased as is the case for oil), this produces a deterioration in trade balance, which will decrease the value of the local currency," it said. DOES INTERVENTION WORK ON EITHER MARKET?

http://in.finance.yahoo.com/news/How-logical-link-oil-dollar-reuters-983570608.html

20-07-2011

How logical is the link between oil and the dollar? - Yahoo! India Finance

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The IEA has maintained so far "a resolutely positive view" of its emergency supply release, which it said had added much-needed supplies of high quality oil to a tight market. It says it has changed the structure of the oil market and narrowed the gap between easy-to-refine crude and heavier grades, even if the price of benchmark Brent crude is higher than before the IEA announcement. OPEC has, however, disputed that the IEA has done anything to quell speculation. Analysts generally say it is too soon to tell how much impact the reserves release has had, although some say oil has become a financial market like any other, including foreign exchange markets, and there is a limit to how much it will respond to fundamentals of supply and demand. "It's a financialised market and it reacts in part as a financialised market," Heiner Flassbeck, a director at the United Nations Conference on Trade and Development, who has argued in favour of increased government measures, including direct intervention, to curb speculation. Julian Jessop, chief international economist at Capital Economics, said the IEA could have changed trader activity. "If the aim is simply to inject a sense of two-way risk into the market and make people think oil prices are not simply a one way bet -- the IEA has succeeded," he said. In March the Japanese authorities led coordinated intervention in the currency markets, buying dollar/yen after the dollar plunged below 79 yen following the tsunami and nuclear disaster. The move stabilised the pair at around 80 yen until last week, limiting the volatility that hurts Japanese exporters. WHAT IS THE IMPACT ON CURRENCIES OTHER THAN THE DOLLAR? The dollar and oil are the obvious couple as the dollar is overwhelmingly the currency of international crude trade. Analysts see little sign that this status quo will change, although individual trades can be carried out in whatever currency is considered appropriate, notably euros. Oil traders and analysts say they monitor the dollar index and the dollar/euro . Some fund managers avoid direct exposure to volatile and highly leveraged commodities such as oil, but see the need for taking an indirect stake, which can be provided by the Brazilian real for instance. Brazil has huge reserves of oil and a fast-growing economy, although the pace of growth and strength of its currency is a concern. In general the currencies of resource-holding countries, as opposed to consumer countries, are positively correlated to the oil price, but Middle Eastern Gulf producers, with currencies pegged to the U.S. dollar, are an exception. Another potential exception can be the Russian rouble as investors remain mindful of a default in the 1990s, said Jane Foley, currency strategist at Rabobank. A lower oil price can also indirectly affect the euro, one of the preferred currencies for reserve diversification. A drop in prices reduces the accumulation of petrodollars by oil-producing economies, and their scope for reserve diversification into other currencies. OIL VERSUS GOLD? Gold is often regarded as a substitute currency and a relatively safe haven for risk-averse investors, particularly those seeking an inflation hedge. Oil can also be an inflation hedge in a portfolio of assets because it is a significant driver of inflation, although the inflation link has been weakened as developed economies have improved their energy efficiency. Both oil and gold are likely to rise in response to a weak dollar, but their relationship is less straightforward than that as oil is perceived as a risky asset and gold as the opposite. "In a risk-on trade, oil will be bought whereas gold is more likely to be sold, so there should be a negative correlation between the two," Foley said. (Editing by Jane Baird)

http://in.finance.yahoo.com/news/How-logical-link-oil-dollar-reuters-983570608.html

20-07-2011