Last week saw positive momentum for oil prices and the week closed on a significant upswing. The key consideration for traders is whether a structural bottom has formed and whether the market dynamics are in place and constructive to a continued move higher, or if we saw simply a temporary correction. One key long term underlying driver for this market that has been under-reported lately is the value of the dollar, and it’s historically inverse relationship with oil.
Much of the talk concerning oil lately has concentrated on the current supply glut. Last week the supply side of the equation provided a break from the constant stream of supply oriented news working against oil prices. While we did not receive news of significant inventory draws in crude stocks, we did see major draws in gasoline, and the momentum into US based oil production slowed. The rig count report from Baker Hughes saw a very modest decrease in the total rig count, and overall domestic production decreased by about 100,000 barrels a day according to the Energy Information Agency. The news did not indicate dramatic reductions in domestic supplies, but a slowing of news indicating increases in supply was enough for a pivot and incremental move up in pricing.
Another factor in oil prices is the overall climate around the dollar. Historically, a weaker dollar has been generally supportive of oil prices over long-term time horizons. With global oil markets being traded in dollars, countries that import oil have more purchasing power with a weaker dollar, which tends to lift prices over time. Traders in the near term could watch the DXY and relative dollar strength as an indicator of forward looking oil prices provided there are no material changes in the fundamental environment. It is important to note that oil and the dollar are not always inversely correlated and there can be extended periods when the correlation fades with fundamental and geopolitical forces having tremendous power to drive oil prices regardless of the value of the dollar. However, in an environment when all fundamental news is baked in, the value of the dollar and its inverse correlation with oil can emerge as a force underlying oil prices.
Below provides a look at what we have seen in the DXY and then USOIL since the 23rd of June. The inverse correlation during that time is clear.
With some support having formed last week via the correction in pricing we saw coupled with a pause in the challenging news on the supply side for at least a few days, and a contrinued breakdown in the dollar, we could see the structure in place for another positive week for oil prices. Without a major catalyst for further downside action, a trader in a binary or spread option could build a strategy to open positions expecting further sideways or incrementally upward movements in price through the early part of the week, especially before data releases later in the week which could provide a pivot point if the picture around supply or rig count changes the game again.