One of them is not showing it’s true colour. WTI or DXY?
WTI and DXY used to show a clear negative correlation. This disappeared in the middle of 2016. Is this a temporary divergence or a permanent change? If the present appearance is temporary only, one of them is going to show it’s true colour soon.
Give this chart of WTI – DXY a bit of thought
This is the daily chart of (USOIL) WTI with DXY for comparison in the bottom window. The duration in this chart is between mid-2014 to present.
- From the left end of the chart to mid-2016, a very clear negative correlation exists between WTI and DXY i.e. when the Dollar Index goes up, WTI falls, when the Dollar Index goes down, price of WTI goes up.
- There is this possible explanation. Think about the Dollar Index as the purchasing power of the USD. The higher the Dollar Index, the more purchasing power the Greenback has.
- Price is what you pay but value is what you get. The value of a barrel of crude oil (WTI) is the number of calories it has to power your car for X kilometres. In this sense, the value of crude oil (WTI) is rather stable unlike it’s price.
- If you are a crude oil producer and your motive is to achieve stability in your purchasing power (for the purpose of running your national budget), then you could afford to sell oil more cheaply when the USD is strong but you have to sell oil more expensively when the USD is weak. This explanation covers the negative correlation between WTI and DXY very well i.e. WTI goes up when DXY falls and vice versa.
- Back to the chart, something happened from mid-2016. Suddenly that negative correlation disappeared.
- Did something change?
- Is the negative correlation still valid or has it broken permanently (temporary divergence or lag happens from time to time and is fairly common)? If their negative correlation is still valid, then it can show up at any time.
- If what we are seeing now is a temporary divergence, then one of them has to show it’s true colour soon. Which one is going to pop?
Note: WTI – DXY is not the only pair to show divergence/break in correlation. I brought up AUDJPY – SiMSCI/HSI sometime ago.
In case some readers find the duration of the chart above too short, this is a weekly chart of the two from Year 2000 to present.