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Conclusion: Lower lows in the price of oil, leading economic indicators in free fall, and a disconnect in the correlation of U.S. dollar down and oil up make us bearish of oil.


As a preamble to this note, and just to clarify the title, we are not technicians.  We use closing prices as a leading indicator for future prices and fundamentals.  When there is consistently declining closing prices, or for that matter consistently increasing prices, it gives us a clue to add to a myriad of other clues, which may or may not lead to an investment action or decision.

As it relates to oil, it is has been recently causing indigestion for more than just the Obama Administration and those trying to plug the BP well in the Gulf of Mexico.  The lower lows we are seeing in the price of oil are also indicative of indigestion for those bullish of oil.

If Dr. Copper has a PH.D in economics (which after reading Paul Krugman lately, we admit a PH.D in economics doesn’t mean much), than oil certainly has an advanced degree in economics as well.  Oil, at times, tends to have a lower predictive ability of future economic growth than copper simply because there are a number of other factors, outside of pure economic growth, that tend to drive the price of oil. Most notably are geo-politics and the fact that a vast amount of oil is held by nations less than friendly to the United States -- the nation that is the largest consumer of oil.

From a pure fundamental perspective, one of the best measures of supply and demand balances for oil is the weekly inventory report from the Department of Energy.  Since a recent trough of 18.7 days of supply on the first week of January 2008, days supply of oil in the United States has been on a steady upwards climb and is currently at 24.0 days of supply.   As the chart below outlines, supply in the U.S. is on the march upwards and to the right.  Growing supply is negative for price.

Lower Lows in Oil - 1


An important consideration when contemplating the future price of oil is the direction of the price of the U.S. dollar.  In 2009, the key factor driving the meteoric increase in the price of oil was the weakness of the U.S. dollar.  As the dollar weakened, the commodities priced in U.S. dollars increased in price.  In conjunction with this, we also saw a marginal increase in global demand due to massive amounts of stimulus being implemented globally.

While we have an expectation that the U.S. dollar will weaken in the intermediate term due to burgeoning domestic debt issues, it is not clear what impact this will have on commodities such as oil.  Over the last few weeks, and as outlined in the chart below, we have actually seen a strong correlation between oil down and U.S. dollar down (as measured by the U.S. dollar index).

Lower Lows in Oil - Oil v DXY

Currently, the U.S. dollar is being trumped as the dominant factor determining the price of oil.   From our perspective, while more difficult to measure, global demand and expectation of slowing growth has become the dominant factor driving oil price.  To highlight global economic activity, we’ve also posted below a chart of the Baltic Dry Index, which has been falling like a proverbial knife for the last few months and is now at year-to-date lows.

Lower Lows in Oil - Baltic Dry Index

As a reminder, the Baltic Dry Index is a daily index posted in London that measures the supply and demand, and thus price, for dry bulked containers globally.  As such, the demand for containers to transport dried goods globally should ebb and flow with global economic activity.   As economic activity declines, or is expected to decline, the demand for containers also declines.

Collectively, lower lows in price, leading economic indicators in free fall, and a disconnect in the correlation of U.S. dollar down and oil up make us bearish of oil.

Daryl G. Jones

Managing Director