Remember the days when hurricanes and geo-political events made oil fly?
Well, according to Olivier Jakob at Petromatrix, those days — for the time being at least — should be forgotten. The correlations between the Dow, the dollar and oil are now so well set, traders simply can’t afford to ignore them.
Here’s a particularly insightful comment from Jakob on the subject (our emphasis):
WTI is still not able to break away from its pure correlation to the exogenous markets of Dollar and Equities. For the last two days WTI and the Dow Futures have run an R square of 0.9 on the intraday 10 minutes and at such ratio it is just possible to beat the theme of purely trading the Dow on oil futures.
It does not make sense per se but that is the way it is and not trading that theme would only be a proposition to provide liquidity to those who are. The problem remains that the real economy works on different principles than computer games and the current asset correlation would not allow an economy recovery to materialize. At current correlations the Dow at 11′000 would translate in WTI at 100 $/bbl which will hurt consumer confidence and demand and cap the recovery.
It seems quite clear to us that the WTI futures market is currently part of a dollar-led asset bubble and irrespective of the oil fundamentals the next input that will be decisive in the direction of oil prices will be the Fed meeting of next week (November 3rd and 4th ). No action is currently expected from the Fed, but it must be also realizing the across asset bubble in formation and at one stage it will have to decide if it wants to start deflating it or letting it run at the risk of having a burst that it can not handle later on. On flat price, we would be very hesitant to trade anything but the Dow and the Dollar until the Fed meeting is out of the way.
And here’s the chart to prove it:
And what’s to blame for all this united cross-asset momentum? Jakob hints it might be down to the world’s newest financial scape goat: high frequency trading.
It is true, after all, that thanks to specialist firms like Madison Tyler and others, HFT is no longer just found in the realm of the equity markets. Indeed, it’s firms like these that might very well be contributing to oil price inflation against the fundamental odds. The sort of inflation that the likes of Opec have long been keen to blame on speculators.
Which is why it’s interesting that Jakob should conclude that Saudi Arabia, which recently decided to protect itself from WTI anomalies by not pricing oil off the WTI Platts benchmark, would better have been served by a campaign to see the Nymex return to open outcry (non-electronic) trading:
Saudi Arabia will start in January to price its OSP for US destination on the Argus sour Gulf quote and the CME was quick to react by announcing that it would launch a Futures contract on the same Argus quote. That move from the CME might kill the benefit for the Saudis of changing the reference quote as automatic electronic arbitrage will likely spill the disconnect of WTI into the gulf quote. In our opinion, the only alternative for a crude oil future to regain some diversification benefit would be to return to full open outcry.
Related links:
Reports of the oil-dollar correlation are exaggerated - FT Energy Source
So who says there’s no oil/dollar correlation? - FT Alphaville
Oil, the great inflation hedge - FT Alphaville
Electronic trading and commodity prices - FT Alphaville
