Olivier Jakob at Petromatrix introduced a new term on Monday: the dowlar.
It’s a reference to the correlation between oil prices and – you guessed it – the Dow and the dollar. It’s a cute term to sum up two of the key non-fundamental factors that are affecting oil prices, in the absence of much data showing a genuine improvement in demand.
Looking at Monday’s markets, for example, Petromatrix noted that the release of ISM manufacturing data triggered a bounce in the Dow, and then in crude oil futures. But none of this, Jakob wrote, gave much hope on oil market fundamentals:
However, in the real world of oil nothing has really changed apart maybe from ICE Gasoil moving into a deeper contango. Yes, the ISM manufacturing index is better than expected, GDP is growing and yes some factories that had been idled have been turned back on; but rail freight in the US is still down -14.8% from a year ago and down -17.3% from 2007 (week ending Oct24). The problem remains that the Distillates being produced around the world is going into the tanks of floating vessels rather than the tanks of 18 wheelers.
The correlation hasn’t held up all week, however. Tuesday’s market broke the ‘dowlar’ correlation because it was India’s huge gold purchase that supported crude prices.
And how about yesterday? The picture gets more confused:
The Fed left most things unchanged, but is that bullish because it allows the resumption of the “dowlar” correlation trade or bearish because it shows that the low interest rates have not yet induced a jump-start to the economy? The intraday correlation have worked less precisely this week and while it is probably too early to call the “dowlar” trading theme off, WTI under that strategy is entering into a zone of downside asymmetric risk. Under the current contango roll, a long-and-hold position at 85 $/bbl would require WTI to close 2010 at 93$/bbl to be break even and at 100 $/bbl would yield a 7% return for a reasonable downside risk of 20%. At current prices, stocks and OPEC capacity levels; buying oil on the dollar can only be a short-term trade and given that Large Speculators have been building record long positions since the start of October we will need to continue to question their capacity to hold these positions rather than trade them.
Whatever it means for the ‘dowlar’, positive signals on fundamental demand for oil certainly aren’t there:
The Fed is not pointing at any strong demand recovery and the US oil statistics are saying the same thing. US demand for petroleum product has been very stable for the last five month and while stability is better than continued erosion it is not yet showing any sign of rebound. October US oil demand is lower than last year by -0.9 myn b/d, lower than 2007 by -1.7 myn b/d and at the lowest demand level for a month of October since 1995!