Outside Economics

With the last summer holiday a couple weeks away oil prices have certainly started to climb as usual. But are the prices going to stick. It certainly seems that over the summer the $40/bbl support level held. That being said now it looks like we may have higher prices heading into the fall.

As oil prices rebounded throughout May and June, drillers restarted idle rigs in hopes of catching higher prices as they evolved. Unfortunately, the upswing in production and drilling was accompanied by growing supplies and less consumption, thus resulting in a supply glut. 

As a group, OPEC represents the world’s largest producer of oil, with Saudi Arabia being the single largest producer at over 10 million barrels per day, roughly a third of total OPEC production.

The dramatic decline in prices in July alone are a testament to the commodity’s volatility, subject to supply and demand dynamics worldwide. Yet even with such an efficient market, as claimed by Saudi Arabia, producers tend to get it wrong as to what the actual demand might be. Some oil analysts believe that OPEC leaders, specifically Saudi Arabia, may have increased production knowing that additional demand was not yet there. 

Crude oil prices traded as high as $107 per barrel as recently as June 2014, and now pulling back to near $40 as of the end of July. As with any drop in commodity prices they eventually go back up, and oil is no different, see The Bounce.

What does this mean for you? Investment wise, it maybe a good time to pick up some oil stocks. Many of these stocks have been trading at less than half their highs from two years ago, so even a small increase in the price of oil can result in a nice return on your investment.

Additionally this will mean higher gas prices at the pump - so budget accordingly. Don’t get caught by surprise when gas soon hits $2.50 to $3.00 or more per gallon. Make other financial adjustments now, so you can handle the higher energy prices to come.

Sources: OPEC Monthly Production Report, OPEC Secretariat, Energy Prospectus Group

REMEMBER:

"One of the most important ways to manifest integrity is to be loyal to those who are not present." - Stephen R. Covey

The economy this past quarter has been a great improvement over the first quarter. I am expecting some market stability as we head into the convention season and through this years election cycle. Who is elected will determine much of what happens next. We are however due for a recession soon, depending on which economist you follow. I fully expect we will see something in the next 12 to 24 months. 

Macro Overview 

The British vote to exit the EU (Brexit) was essentially a validation that a disintegration process of the EU is possibly underway, causing destabilization for countries throughout the EU. Britain’s vote may lead to other similar referendums, particularly with the Netherlands and France where populist sentiment is growing.

The British pound fell to a 30-year low versus the U.S. dollar following the outcome of the referendum. Conversely, the fall in value for the British pound can be beneficial for the country as Britain’s exports become cheaper worldwide and tourism increases as stronger foreign currencies come into the country.

The unraveling of Britain from the EU is not expected to be automatic or immediate and may take years for it to finalize. Britain would need to execute a divorce clause titled Article 50 of the EU agreement in order to move forward with the separation from the EU. Several member EU countries, including the IMF, are eager to have Britain expedite the exit in order to minimize uncertainty.

In the wake of the referendum’s outcome, international equity markets tumbled as uncertainty led the course. U.S. financial markets were incredibly resilient following the days after the British EU vote, with U.S. equity and bond prices all propelling to higher levels. 

The Fed’s plan to further increase rates this year took a different course as the repercussions from Britain’s EU vote are expected to lead to slowing economic growth and a sustained low interest rate environment. Some Fed watchers believe that the Fed may ramp up its stimulus efforts again with lowering rates should the EU and Europe’s economy falter.

Overshadowed by the Brexit news, the U.S. Census Bureau reported data that may help solidify the Fed’s wait to raise rates. Durable goods orders fell 2.2% in May, worse than anticipated. Such data is an indicator of whether inflationary pressures are present and if inconsistent expansion exists in the economy due to less capital spending.

In the midst of the Brexit turmoil, the Federal Reserve announced that 33 selected U.S. banks passed an imposed stress test to see how well they would perform under severe circumstances, such as high unemployment, recession, and falling asset prices. The stress test revealed that the 33 banks tested had nearly twice the amount of required capital needed, up significantly from the last stress test conducted.

Equity Update – Domestic & Global Stock Markets

U.S. stocks fared better than international stocks following Britain’s announcement on leaving the EU. U.S. equity markets were resilient once the surprise of Brexit unfolded, with the S&P 500 Index and the Dow Jones Industrial Index both positive for the year.

Domestic equities are more insulated from global developments and any other major equity markets since American companies generate 70% of the revenues from the United States. Japanese companies generate 50% from within their economy only and European companies generating a mere 49% from Europe only.

U.S. equities are considered attractive relative to negative yielding government bonds in Asia and parts of Europe, even as the U.S. 10-year note finished below 1.5% in June. The S&P 500 index currently carries 60% of its stocks with a dividend yield higher than the 10-year treasury bond yield.

The primary British equity index, the FTSE 100, tumbled in June following the Brexit vote. Companies within the index generate about 75% of their revenues outside the U.K., with many maintaining contracts and arrangements with other companies based in other EU countries. Since the actual extraction of Britain from the EU may take years, decisions for capital spending and expansion by European companies may be hindered.

Certain equity sectors are becoming increasingly sensitive to what the presidential candidates are proposing.  Concerns lie with those sectors where newly enacted regulatory policy can inhibit growth and profits. Other sectors are being adversely affected by low rates, such as banks whose earnings are hindered by low rates, which limits the amount of profits they can earn as deposits fall and loan rates drop.

Precious Metals, Oil & Gas, and Wages

Precious metals have increased dramatically this past quarter. Economist, Mark Skousen, said, “I think they (Federal Reserve officials) are working overtime to bring inflation back. Gold, which is finally moving, is the best indicator of future inflation. So we may see a return of inflation here if the gold market continues to rise. So that's what I'm looking at more than the bond market.”

Silver has rallied this year increasing nearly about $6.30 per ounce over the $13.83 at the start of the year. That is a 45.55 percent increase in price. For the past several days it has reacted independently of gold as gold prices have come down a bit; Silver has continued to go up. It seems there may be some hedging going on due to Silver’s expanded use in industrial applications. These are the highest prices for silver since the summer of 2014.  

Oil and Natural Gas are also on the rise. According to Dan Steffens, President of Energy Prospectus Group, (EPG) of Houston, TX, “The combination of rising demand and falling production has pushed the natural gas prices up from $1.70/mmbtu in February to near $3.00 at the end of June. My prediction is now we will see gas trading for more than $4.00/mmbtu by December.” If that is the case, lets hope all the global warming kicks in so we have a mild winter or we will be paying more than double for heat.  

With U.S. oil production down from last year, we are back to importing about 50% of our oil. Other countries are having production issues too, which may cause an increase up to about $70/bbl by the end of the year. Third quarter typically sees an increase in oil demand due to summer travel, which could easily eat up the surplus that has been keeping oil prices low. Some analyst think that oil will remain fairly steady around $50/bbl for the near future.

The Department of Labor reported that average hourly earnings grew by 2.5% over the past year, thus placing pressure on corporate earnings as wages move up. Many analysts believe that wages will continue to increase as unemployment rates remain below 5%, enticing companies to keep performing workers and paying them more.

After a market run up as we have seen this past quarter, I would not be surprised to see some profit taking in the next couple months, particularly if this earnings season does not produce any great results. If inflation takes off  then expect oil, precious metals, wages and other commodities to increase, which will certainly put pressure on corporate profits, and will also stress the markets. Now is a good time to continue to get out of debt and put a little extra away for a rainy day. 

Kind Regards,

Your Arm-Chair Economist

Sources: Eurostat, Department of Labor, S&P, Bloomberg, Federal Reserve, U.S. Census Bureau, EPG

Last week we looked at our inflation, now we will take a looks at what hyper inflation looks like  for one of our neighbors to the south. The price of oil has affected many economies around the world. It has hurt our economy in many ways, and helped in many other ways. But our economy is we diversified which is why the low price of oil has had such a balancing effect in our economy - other countries are not so blessed. 

One major oil exporter, Venezuela, is particularly hurting because of the low oil prices. As oil became the main income source, the country began to ignore other industries, like agriculture, and thus requires most of their food to be imported from Columbia and the United States. 

Before the 1950s agriculture was greater than 50 percent of Venezuela’s GDP, now it accounts for approximately five percent of GDP. This is a serious problem for the country’s leadership. As oil prices drop they are truly hurting. Its like still needing to feed the family on half the income; some things you can no longer afford and you don't have the economic base to find the income from other sources.

With oil exports accounting for over 95% of Venezuela’s revenue, the 50% collapse of oil prices in the past two years has thrown the country into fiscal and political turmoil. In order to raise critical cash to keep the government operational, officials have started to sell the country’s gold reserves. 

Even though the country is a major exporter of oil, it is also a major importer of essential goods for its citizens. The country’s currency, the bolivar, has collapsed to the value of one U.S. cent, creating hyperinflation which led to prices soaring over 121% in 2015, and expected to rise nearly 500% in 2016, as estimated by the IMF.

Inflation of this magnitude is similar to having a massive heart attack after twenty years of high blood pressure! It can really kill an economy!

In addition to its fiscal woes, the country is also suffering from little rain, which has brought about severe electricity shortages due to its main source of power generation, a dam whose water levels have dropped to historical lows. In late April, the country’s president ordered a two-day work week for government employees, in order to stem the consumption of electricity. The government workweek now is down to Mondays and Tuesdays, affecting roughly 2.6 million employees, representing 20% of the nation’s workforce.

Economic conditions have worsened, as the economy shrank 5.7% in 2015 and is projected to shrink another 8% in 2016, as estimated by the IMF. Such dire circumstances have created concern among U.S. officials, which are increasingly worried about an unraveling socialist economy and a political meltdown. Such an occurrence could lead to social unrest, chaos and political instability, causing tensions to rise with neighboring countries in South America.

So why is this important? Well hopefully two reasons: 1. perhaps it will bring about a political change, which will move the country back to a democracy and a free market economy and away from its current socialist/communist government. 2. hopefully they will begin to expand their industrial base and grow into other industries besides oil. Any time an economy is based on a single product the risk goes way up for future economic troubles.  

Additionally, it would be great for our two countries to get along better - geographically we are very close to Venezuela (less than 1400 miles) and the several people I know from Venezuela are wonderful people!

Sources: IMF

Remember:

There are plenty of good five cent cigars in the country. The trouble is they cost a quarter.
Franklin Pierce Adams

Equity markets rebounded in March as rate hike fears eased and healthy domestic economic data revealed consistent conditions, resulting in a resounding turnaround from the market lows experienced in February. Market volatility appears to be mellowing compared to a year ago (except for oil). “With Volatility trending lower assets further out on the risk spectrum, such as Emerging Markets, Small Caps, and High Yield rallied.”

This first quarter has seen a healthy run up in the prices of gold and silver, however the returns are fading as profit takers sell off. Some of the reason for the price moves, poor stock market return, fears about interest rate hikes, on going inflation worries and currency weakness. Some analysts believe that gold will drop back to support level of about $1,150 per ounce by third quarter; while Credit Suisse has increased its forecast for first quarter 2017 to $1,313 per ounce and Silver to $16.50 per ounce. Whom ever you believe it appears that at current prices gold and silly er are still pretty good buys. 

The concern of a rapid rate increase by the Federal Reserve subsided towards the end of the 1^st quarter, as Fed Chairperson Janet Yellen helped tame prior remarks made by fellow Federal Reserve members. Subdued inflation and economic growth expectations led the Fed to curtail its stance on predetermined rate hikes. The Fed identified “global economic and financial developments continue to pose risks”.

Labor Department data released for the first week in March showed that merely 253,000 Americans filed for unemployment, the fewest number since 1973. Economists view the lessening amount of unemployment applicants as a validation that the labor market continues to steadily strengthen.

Additionally, the Labor Department’s monthly employment report for March showed a 215,000 increase in jobs, with an increase in the unemployment rate to 5% from 4.9%, signaling that more people have entered the labor force.

Some analysts believe that oil may have found a bottom around $26 per barrel in the first quarter, alleviating fears of a further oil price drop. Oil prices recovered in March from persistent lows earlier in the year. This recovery will help strengthen the economy - a fair balance in oil prices will only help keep things moving.

Easing rate hike concerns led to the dollar’s derailment from its uptrend during the quarter, creating opportunities for additional exports, as American made products become less expensive for international buyers.

A new acronym arose from international central banks lowering rates to negative territories, NIPR (Negative Interest Rate Policy). The Bank of Japan adopted negative interest rates in January and lowered key lending rates to below 0%, nearly a year and a half after the European Central Bank became the first major institution of its kind to venture below zero. Other countries meandering into the negative arena include Switzerland, Denmark and Sweden.

The ECB ramped up its economic stimulus efforts in Europe by increasing its bond purchases from 60 billion euros to 80 billion euros per month. In addition, the central bank will be buying both government bonds and investment grade corporate bonds. Markets welcomed the strategy of venturing into the corporate realm, sending bond prices higher due to a limited supply of the debt.

The economy continues to worry many people, I see many people who have just been laid off from their job, which is a very big concern. This gives rise to worries about a future recession - some analysts talk that we are long over due, others say that we have not fully recovered from the last "Great Recession". Personally, I think while the technical definition of a recession ended in 2009, we have not fully recovered. For many people it certainly does not feel like it has ended, as they are not any better off. They feel like they are still treading water. However I don't see the U.S. slipping into a recession until after the presidential election this fall, so maybe in the first half of 2017.

Sources: Fed, Dept. of Labor, Eurostat, ECB, Dept. of Energy, State Street Global Advisors

Each month, the Energy Information Agency (EIA) tracks the price of gasoline nationwide as well as how much households (consumers) are buying overall.

The EIA expects gasoline prices to start rising this year, while continuing to head higher into 2017 as demand picks up and supply levels drop. Gasoline prices had been falling because of lower crude oil prices, which account for about two-thirds of the price U.S. drivers pay for a gallon of gasoline.

Increases in fuel economy are also contributing to lower fuel expenditures, as cars and trucks are more efficient and travel farther on a gallon of gasoline. According to the Environmental Protection Agency, the production-weighted fuel economy of cars has increased from 23.1 miles per gallon for 2005 cars to almost 28 mpg for 2014 cars, an increase of over 20%. Similarly, the fuel economy for trucks has increased 19%, from 16.9 mpg to 20.1 mpg in the same timeframe.

The Consumer Price Index (CPI), a statistical measure of inflation, has gasoline accounting for 5.1% of consumer spending as of October 2014. Reductions in gasoline prices ultimately impact the relative weight of gasoline compared to other expenditures such as shelter, clothing, food, and entertainment in price indices compiled by the Bureau of Labor Statistics (BLS) and the Bureau of Economic Analysis.

The demand for gasoline is very price inelastic over short time periods, meaning changes in price have little impact on the number of gallons used. Falling gasoline prices allow households to spend their income on other goods and services, pay down debt, and/or increase savings. However, the longer prices remain low, the more time households have to plan for driving vacations and decide on where to spend their excess money.

Sources: EIA, Commerce Dept., BLS, EPA

Remember:

"If you can't make them see the light, make them feel the heat." - Ronald Reagan

A few interesting facts about Iran will help put some perspective on the current status of the world economy. Iran is a country that is rich in other natural resources besides oil and they have a history of being an economic powerhouse in the Middle East region.  It will be interesting to watch how they play their new part on the world stage.

Sanctions imposed on Iran years ago were lifted in January thus allowing Iran to once again export and compete in the global economy. At the height of the sanctions, Iran saw their currency, the rial, collapse by over 80%, sending food and basic product prices to hyperinflation levels.

Iran has an abundance of natural resources it plans to export, including zinc, copper, iron ore, and oil. Iran’s announcement that it will begin adding another 500,000 daily barrels of oil to world oil markets helped sink oil prices further in January as an oversupply issue was magnified by Iran’s new production.

Iran is already the world’s third largest exporter of steel. Iran also has about 18% of the world’s natural gas reserves. Iran was also the first country in the Middle East to discover oil in 1902. It is estimated that Iran has proven oil reserves of 157 billion barrels, representing about 9% of the world’s proven reserves. This is a sore fact for Saudi Arabia, which is a vehement rival to Iran, both financially and religiously.

Demographically, Iran has a young and highly educated population, adding to its vitality and stockpile of a talented labor force. Some economists have identified Iran with Germany, calling it the “Germany of the Middle East”. If this is true then Iran can rise from the ashes and become a real economic powerhouse like Germany has post WWII. However because Iran still lacks the God given human rights, as many nations in the free world have, similar to our Bill of Rights, that are part of the U.S. Constitution, they will never mature to the same status as Germany has, never mind their oil.

Sources: CIA Factbook, IEA, Eurostat

Remember

Talk is, that one of the reasons the market is falling right now is because it was overpriced, which may be the case, however another part of the problem has been that when considering options, where else can you put your money?

Banks aren’t much of an option – at the continuously low rates it makes it pretty painful to leave money there. At least when rates were higher and a depositor could get 4%-6% at a bank you had a fairly good risk free option. Too much cash on the sidelines will certainly cause the market to be bid up. Maybe it’s an issue of supply and demand – there aren’t enough shares to go around, so the prices get bid up.

Insurance companies, which are very long-term investors, are currently running about 2-4X or more the rate banks are offering. These rates are certainly going to help folks get better returns, with little to no risk. But when chasing performance even those stable rates don’t appeal to everyone. So this week I thought we would look at one reason why the market has tanked over the past several weeks, and consider the option of putting more money in the market – after many of the stocks and bonds are clearly on sale!

Below is a look at why the markets are falling, what is up with bonds, and a check on precious metals.

Why Stocks Went Down When Oil Went Down – Domestic Equities

Equity markets descended in January alongside oil prices, while testing new lows with a visible increase in volatility. Oil’s dramatic price drop has been a catalyst for stock prices heading lower, a so-called correlation that has actually existed for years.

There are various theories as to how oil and stock prices might be correlated, yet one of the most accepted revolves around macro economic global dynamics.

Oil is the most traded and actively utilized commodity in the world whose consumption represents the economic activity worldwide. So when oil supplies grow and demand drops, markets interpret that as an economic slowdown. Such a slowdown thus migrates into the equity markets, where economic activity and growth is essential for expansion and higher equity prices.

Lower oil prices can also be beneficial for certain sectors, such as consumers, transportation and airlines, whose primary expenses are fuel. Economists expect a possible lag effect with recent low oil prices, which may eventually appear on corporate income statements. Obviously, lower oil prices are not conducive to oil industry sector companies, whose margins shrink as oil prices drop.

Some fixed income investors now view U.S. energy stocks as opportunities to earn higher yields on dividends compared to where they were months ago. Lower valuations on energy stocks have led to higher stock dividend yields as prices have fallen.

Does this mean that the markets won’t recover until oil prices go up? For that answer only time will tell…

Fixed Income – Global Bond Markets

The Fed is now at odds with nearly every other developed country central bank as others employ a rate decrease and stimulus strategies.

In its latest FOMC meeting in January, the Fed decided to leave its rate hike plans intact, disappointing markets and lifting U.S. rates slightly. The Fed did acknowledge slightly lower economic growth and volatile equity market conditions as variables to monitor.

International rates fell in January as central banks moved forward with stimulus efforts aided by lower borrowing rates. The ECB and Japan both reduced their key lending rates enough to drive markets in both regions towards risk assets. Japan’s central bank surprised markets by lowering one of its main lending rates into negative territory for the first time in order to stimulate its sagging economy.

Gold and Silver - What's Up?

Considering the markets and the downward trend, it seems that Gold and Silver (precious metals) have come off the winner over the past couple months. Both gold and silver are up, about 14% and 10% respectively. It makes sense to own some precious metals, but as with any investment how much higher will it go? Typically, people own precious metals as a balance to inflation but it can be a stabilizer to an investment portfolio.

With that news, it looks like for the time being, Gold is floating to the TOP! So does this mean we are at the bottom of the current sell off? No, perhaps but not likely. Does it mean its time to put more money in the market and buy while things are on sale? Maybe. Many of these answers are particularly personal to your current situtation that is why a good comprehensive evaluation is valuable.

Sources: Federal Reserve, Bloomberg, Economic Premise #150 World Bank, IMF Research Bulletin, Federal Reserve System Perspective

Remember:

"The hardest thing in the world to understand is income tax." - Albert Einstein

A 40-year ban on U.S. oil exports was lifted as the House of Representatives and Senate passed a spending bill that included the dismantling of the decades-old rule.

In response to the Arab oil embargo, the U.S. imposed regulations in 1975 that restricted the exportation of crude oil. For years, oil companies and industry leaders have sought a relaxation of the export restrictions in order to compete in the global oil markets.

As oil production has risen, so have the inventories and stockpiles of crude oil. With a growing supply of crude oil reserves, oil companies are eager to export crude to satisfy demand from foreign countries. Net crude oil imports have dropped nearly 25% over the past five years, as U.S. production has steadily increased.

The growth of the oil industry in the U.S. has been a significant help our economic growth these past several years since the Great Recession in 2008. It has helped provide jobs in many sectors as companies have scrambled to ramp up to serve the oil industry. While global oil prices are down now, many of the more established companies are still profitable, many are looking for a merger opportunity to keep going.

According to the Energy Information Administration (EIA), U.S. oil production averaged about 9.45 million barrels a day in 2015, marking the highest production levels since the mid 1980’s. At 487 million barrels at the end of December, U.S. crude oil inventories remain near levels not seen for this time of year for the last 80 years.

As the U.S. has increased crude oil production, demand for U.S. oil has also risen worldwide. In the international oil markets, there are two primary types of crude oil: West Texas Intermediate (WTI) and Brent Crude. Both are used as benchmarks in pricing oil worldwide, with varying prices depending on existing supplies.

WTI is also known as Texas light sweet (Texas Tea) because of its relatively low density, light characteristics and sweet because of its low sulfur content. Conversely, Brent Crude is a bit heavier and not as sweet, thus making WTI a higher quality oil and more desirable worldwide. The lighter and sweeter WTI is easier and less expensive to refine and distill into gasoline, diesel, jet fuel, and other fuel products.

For the past few years crude oil production in the United States has surged tremendously because of the technology behind horizontal drilling and hydraulic fracturing, primarily in the states of North Dakota and Texas.

The United States is becoming one of the world’s leading oil producers and refiners, it is considered good for economic and job growth nationwide. Inexpensive crude along with an abundance of supply in the United States has allowed refiners to become extremely profitable and capable of efficient refining.

The International Energy Agency (IEA) estimates that any exports of U.S. crude oil will be quickly consumed by the international markets and help stabilize any supply inefficiencies caused by political uncertainty in the OPEC countries.   

Divergence of WTI and Brent Oil Prices

West Texas Intermediate (WTI) represents the price that U.S. oil producers receive and Brent represents the prices received internationally. The two prices have been diverting due to a recent surge in production in the United States that has caused a buildup of crude oil inventories at Cushing, Oklahoma, where WTI is stored and priced. Before this increase in U.S. oil production, the two crudes had historically traded in line with each other. 

Realization of an oversupply issue put pressure on oil prices throughout 2014 & 2015. Crude oil production in the U.S. has surged because of the technology behind horizontal drilling and hydraulic fracturing, primarily in the states of North Dakota and Texas. Fracking makes it possible to extract oil and natural gas in places where conventional technologies are not effective. Fracking involves the use of high water pressure combined with sand and chemicals to create cracks in rock that allow the oil and natural gas it contains to escape and flow out of a well.

Both oil benchmarks have fallen substantially over the past two years. Brent lost 48% in 2014, followed by a 35% loss in 2015. WTI lost 46% in 2014, followed by a 30% loss in 2015.

Sources: IEA, EIA, Commerce Department

Remember:

"Truth will rise above falsehood as oil above water." - Meguel de Cervantes

Commodities, such as oil or gold, typically follow an inverse, or negative relationship with the value of the dollar. A stronger dollar makes oil a less attractive commodity on dollar-denominated exchanges, especially in the eyes of investors holding other currencies. When the value of the dollar weakens against other major currencies, the prices of commodities generally move higher.

This inverse relationship also happens when countries devalue their currencies through inflation. This is one argument for the gold standard, it is said to keep monitary policies honest.

There are many reasons why the value of the dollar has an impact on commodity prices worldwide, namely commodities are typically priced in dollars. When the value of the dollar drops, it will take more dollars to buy the same amount of commodities. Commodities are traded in dollars because currently the dollar serves as the world’s reserve currency. Some countries, like the BRIC’s (Brazil, Russia, India and China are trying to change that and use the Chinese Yuan as a reserve currency or a basket of currencies from other countries rather than simply the US dollar.

Another reason is that commodities are traded around the world; foreign buyers purchase our commodities: corn, soybeans, rice, wheat, oil, etc., with dollars they have received in trade as we have purchased products they have manufactured. When the value of the dollar drops, they have more buying power and simple economics tells us that demand typically increases as prices drop.

Commodity traders often keep a close eye on the value of the dollar. An easy way to monitor the dollar is to watch the price quotes on the Dollar Index on the ICE Futures Exchange. It is an index of how the dollar is valued against a group of other major currencies around the world. The price of the index is traded like any other futures contract and you can get quotes throughout the day.

Commodity prices don’t necessarily tick higher for every tick lower in the Dollar Index, but there is a strong inverse relationship over time. Individual commodities can also buck the trend if other over whelming forces are causing the price to move along with the dollar.

Lately the dollar has gained strength against a backdrop of many countries whose currencies are weakening. This has been a factor in the lower prices we have seen at the pump. This strengthening has also had an impact on other commodities, precious metals, gold, silver, platinum, etc.

Typically, gold is seen by investors as a backup for the dollar. As the dollar weakens, the price of gold increases. As the dollar gains strength, gold prices drop. It is similar to the relationship between the dollar and oil. Which begs the question, is there a correlation between oil and gold?

There are a couple ideas that try to explain the correlation between gold and oil. One is that prices of crude oil partly account for inflation. Increases in the price of oil result in increased prices of gasoline at the pump. If fuels (gasoline, diesel oil, and aviation fuel) are more expensive, then it’s more costly to transport goods and those prices go up. The final result is increased prices – in other words, inflation.

The second thought on the oil-gold link is the fact that precious metals tend to appreciate when inflation is rising (especially in the current fiat monetary environment). So, an increase in the price of crude oil can, eventually, translate into higher precious metals prices resulting in oil becoming a new economic bench mark similar to gold.

While it usually takes some time for higher commodity prices to materialize as higher prices in goods and services, however for precious metals they trade daily in your portfolio and may trade in line with oil immediately. One explanation can be that, once oil appreciates, precious metals investors correlate the expected future higher prices of goods in the price of gold and it generally goes up.

However, even though the general price level of gold moves in a similar direction to oil, the relationship may not be trade-able based on data for the long term. While the correlation is positive, over longer periods of time and on average, this relationship does not always translate the same for gold and oil returns.

In 2000 oil was trading around $32 per barrel and gold was around $292. Currently oil is trading around $75 and gold at $1,183. Which translates for oil a 134 percent gain over the past 14 years and 305 percent gain for gold. (Obviously, these are low compared to recent highs in the past few years when oil hit around $140 per barrel and Gold was up around $1,800 per ounce.) By comparison, in January 2000 the CPI was at 168.800 and January 2014 the CPI was 233.916 or an increase of 38.6 percent. The low inflation rate compared to the increase cost of oil and gold can partially be explained by the number of times the Government has revised the method of calculating the CPI.

Having said that, it’s still possible for short-term patterns to emerge occasionally. So, even though there seems to be no relationship between gold and oil returns over the long term, it may happen that a relationship unveils itself in a short period of time offering trading opportunities.

In summary, while oil prices do not drive gold prices and gold does not drive oil prices, the main reason the two markets have similar long-term trends, as well as other commodities, is that they have one important long-term driver in common: monetary inflation.