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Tuesday June 28, 2005 - 10:50:44 GMT
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Oil, gold, fed funds and the buck


“Modern crowd theory effectively asserts that crowds emerge as a result of the same basic laws which apply to the rest of nature. As Erich Jantsch has shown, building on the implications of quantum physics, all of nature consists of multi-leveled structures. Each level in this hierarchy has the power to organize its lower levels and use them for its own purposes. Consequently, each level is able to perpetuate itself, or maintain its identity, despite changes in its individual components.”

Tony Plummer, The Psychology of Technical Analysis

FX Trading

With crude oil prices extending into nose bleed levels, global growth concerns grow. No surprise there. What we were wondering, and still are, is whether the rising cost of oil:

A) Acts to create a drag on the economy such that the Fed will temper any future rate hike plans,


B) Induces the Fed to be more aggressive

The answer may have some bearing on what we are really trying to get at—what’s the potential impact on the dollar. If A), a more subdued Fed, with just one more hike up its sleeve, would meet current expectations and probably be a net negative for the buck—supporting our technical correction view. But, if B), it could mean correction cancelled, and the dollar makes yet another leg up on positive interest differential i.e. exceeding current market expectations.

I know it’s a circuitous route. (This game of predicting interest rates, then predicting the dollar, is quite a silly one. For if we could forecast rates, we stop worrying about the buck, buy a seat on the Chicago Board of Trade, become zillionaires, and live happily ever after. )

With that caveat in place, we forge ahead anyway.

Regular readers are familiar with the Gold/Oil chart we have referred to here a few times in the past. For those that haven’t seen it, it’s you lucky day—time for a quick review. For it is the cornerstone of today’s weighty tome.


Ok…crude prices have surged…and they have surged in real terms. Real terms being defined as how many barrels of oil one once of gold will purchase—now its at around 7.3 barrels. That’s not much.

The next step was to add another price series to the already esoteric chart—so that we could make yet another conjecture.


This chart shows our same Gold/Oil chart vs. Fed Fund futures inverted (inverting FF shows short-term rates rising). Notice as Gold/Oil ratio bottom near the current range in the past, Fed Funds rate tended to peak! (That’s represented by the series of circles on the chart.)

You can also see there appears to be times when Gold/Oil peaked, while Fed Funds tended to bottom.

This would suggest the price of crude oil, rising in real terms, leads the Fed to temper or even loosen monetary policy—and in fact might induce a cut in interest rates. After all, we are witnessing one central bank after another leaning toward rate cuts—following the Swedish central bank’s 50-basis point surprise last week.

Just for the heck of it, we have added yet another price series to the chart—the US $ Index (blue line):


As we said yesterday, we believe the rising US dollar yield differential is the key driver for the buck this year—despite the threat from the Double-D’s of Doom. (Double-D’s of doom are the current account and Fed budget deficit). If you look hard into the chart above, you can see the Fed Funds (red line) leading the dollar since around 1998. Ok…so what?

So, if rising crude is a driver to make the Fed pull back on the reins, we expect the dollar to stage the correction we have been searching for. Otherwise, it may be time to switch sides and play for another leg up in the buck. Yet, on the other hand…

Jack Crooks
Black Swan Capital


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