Despite the negative news on the attempt to freeze output among the major suppliers, the quick drop in oil has been reversed, and it's (WTI) heading over $40 again. Is this irrational behavior?
The main driver in the news today is the drop in the dollar. Analysts discuss this relationship as if it's "natural"--as the dollar falls, commodities priced in dollars rise because they are cheaper in terms of other currencies. However, this negative correlation was non-existent until commodity markets became financialized, formally through deregulation in 2000 (the Commodity Futures Modernization Act). Prior to 2000, the simple correlation in oil prices and the dollar was near zero, and there were even periods of positive correlation. Since 2000, the simple correlation between prices has been about -0.8, the perceived natural relationship.
In my view, now that hedge funds and other investors dominate trading in commodity markets--especially oil, they have incorporated this "trade" into computerized models. So, we end up with what appears to be a conundrum: despite the lack of agreement on supply and continued growth in oil inventory, the dollar-oil trade fuels a nice price rise.
Ahhh...the difficulty of predicting short run price movements....
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