Here we go again. At Friday's close both the spot price and the January contract settled at $89.19 per barrel. From Bloomberg's report—
Oil jumped 1.4 percent as the Dollar Index (left) dropped to the lowest level since Nov. 23 after U.S. employers added fewer jobs than forecast in November...
“The rally is due to a much lower dollar,” said Hamza Khan, an analyst with Schork Group Inc., a consulting company in Villanova, Pennsylvania. “This is not based on fundamentals.”
Oil for January delivery rose $1.19 to settle at $89.19 a barrel on the New York Mercantile Exchange, the highest closing price since Oct. 7, 2008. Futures increased 6.5 percent this week and 12 percent this year.
I have warned that oil was about to break $90/barrel in the past, but it didn't happen. Will it happen this time? God only knows. Given the troubles in Europe, the dollar may rally against the Euro. It seems that anything can happen in the markets. They were already grossly distorted, but QE2, the debt crisis in Europe and other factors have made a mockery of apparent trends.
Economist James Hamilton weighed in on commodity prices on November 10. He cites new evidence that commodity prices move together, which is certainly not a surprise.
Rolling-window correlation between oil prices and copper prices. Recent research by Ke Tang and Wei Xiong documents that the correlation between the price changes of different commodities has been increasing over time. Here for example is the correlation between the changes in oil and copper prices. These two prices were essentially uncorrelated in 2001. Back then, in a week when oil prices went up, the price of copper was just as likely to go up as down. Over the last few years, however, the two prices have been much more likely to move together.
And there is the renewed strong correlation with the dollar/euro exchange rate. Again, not a surprise.
Rolling-window correlation between oil prices and exchange rate. Another changing correlation over time is that between commodity prices and the exchange rate. Here for example is the correlation between the weekly change in the dollar price of oil and the weekly change in the number of dollars you'd need to buy one euro. In 2001, the correlation was actually negative for a while, because news of a weakening U.S. economy would cause both the dollar to depreciate and the dollar price of oil to fall. In recent years, however, the correlation is positive and quite strong. In the year ended September 1, a 1% depreciation of the dollar would typically be associated with a 1.3% increase in the dollar price of oil or copper.
I feel that there is a pretty strong case for interpreting the recent surge in commodity prices as a monetary phenomenon. Now that we know there's a response when the Fed pushes the QE pedal, the question is how far to go.
My view has been that the Fed needs to prevent a repeat of Japan's deflationary experience of the 1990s, but that it also needs to watch commodity prices as an early indicator that it's gone far enough in that objective.
In terms of concrete advice, I would worry about the potential for the policy to do more harm than good if it results in the price of oil moving above $90 a barrel.
And we're uncomfortably close to that point already.
Yes, uncomfortably close. I dont' think the Fed gives a damn about rising commodity prices and their effects on ordinary Americans. At the very least, there's no evidence I'm aware of that the Fed pays any attention to the price of oil, copper, wheat or anything else. But Goldman Sachs makes money, so it's all good, right?