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The plunge in oil prices from the recent high at $115/bbl to the current $95/100 area has turned all markets on their ear. Naturally, arguments abound as to what comes next - bullish and bearish.
Bears point to potential slowing growth from an already anemic recovery and further consequences of the Fed’s ending of QE2, while others, perhaps incorrectly, point to the deflating of a commodity bubble altogether. This argument holds little weight as it seems to lack a connection with reality. Consider the following excerpt from one of our favorite market commentators because he actually put his money where his mouth is, Bill Fleckenstein. Granted his comments focus on silver, but it gets the point across on commodities in general.
Bill cites a recent article in the Financial Times:
“Speaking of silver, yesterday's Financial Times ran an article by James Mackintosh that was even more absurd than even the wildest claims by any of the bulls. In his opening paragraph he wrote, "Last week, one of the biggest bubbles of the past century seemed to have burst. Silver stumbled. . ."
Bill retorts:
“Does he really think that the recent silver rally was larger than the last decade's stock or real estate bubbles, which impacted the entire country and cost trillions of dollars, or the 1980s Japanese version of the same thing? Just where does the FT find these fact-challenged precious metal haters?
Lastly, isn't it ironic that only those who missed every single one of those bubbles think the precious metals are bubble?”
While we find more relevance with the weak economic argument, we do see the recent tumble as technically significant and until price action proves otherwise, oil should fall further. The chart of oil below highlights our rationale.
 Click on image to enlarge!
Calling the direction in one thing, and as noted, we are bearish until proven otherwise, but which currency will be most impacted by a declining oil price?
From a pure economic/fundamental standpoint, oil prices impact an economy/exchange rate from four fronts:
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Trade flows
- Capital flows
- Consumption
- Monetary policy
While there are numerous reports out there that go into depth on each of these topics, we will merely focus on some broad conclusions. This alone, when combined with shorter-term technical analysis should allow traders to correctly position themselves on the right side of the trend. Hence, weak oil prices, based on the criteria above, would have the largest impact on (in order):
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Australian dollar (AUD)
- Norwegian krone (NOK)
- Swedish krona (SEK)
- New Zealand dollar (NZD)
- British pound (GBP)
The U.S. dollar actually would rise in a weak oil price environment. While this may oversimplify something as complex as oil and FX prices, it does offer insight that may at least keep you from bucking the trend.
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