There’s a lot of talk about how the US Dollar is affecting the price of crude oil. To what extent is the US Dollar affecting the price of crude oil and how can I use warrants to profit from price movements?
Before I begin discussing the question it must be said that while the fluctuation of the $US and the price of oil are inextricably linked, the price of crude oil is also subject to a broad and far-reaching range of independent supply and demand drivers.
With that said, a declining $US will generally place upward pressure on the price of crude oil (and vice versa). This observation is, of course, based on the assumption that all other supply and demand issues remain equal. There are numerous reasons behind this but I will focus on the two primary considerations I believe are fundamental to this correlation.
As widely reported, the $US has experienced downward movement lately as the effects of the sub-prime mortgage fallout and the country’s stance on fiscal policy take toll. This has impacted the price of crude oil in one simple way. A weaker US dollar means that those countries with relatively stronger currencies (such as the Euro, Canadian and Australian Dollar) are able to import oil at a lesser cost. This fuels demand which in turn places upward pressure on the price of oil.
Another factor which affects the relationship between fluctuations in the $US and crude oil prices is the impact of activity on the futures markets.
The US dollar’s descent has drawn investors to crude futures contracts as a hedge against the weakening currency and made $US denominated oil futures less expensive to people dealing in other currencies. Dually, the emergence of the crisis in the U.S. sub-prime mortgage sector has shaken the world’s major financial markets, and consequently, there has been more inflows of speculative capital in the oil futures market, with investors trying to avoid risks brought about by turbulence in stock markets. This increased demand for oil futures is also affecting the price.
An investor can benefit from the movement of crude oil by purchasing a warrant. Warrants allow investors simple access to global commodity markets and involve two simple actions. An investor must determine the timeframe and take a position on whether the chosen commodity market will be bullish or bearish (i.e whether you believe the price will go up or down). The benefit of a warrant is that it is a leveraged investment so, like a CFD, it can deliver significant gains on the upside. But unlike CFD’s there are no margin calls and one cannot lose more than their principal investment on the downside.
So as you can see there are several ways foreign currency affects commodity prices, especially given it is used by some sophisticated investors to offset the volatility inherent in foreign exchange markets. The most simplistic representation is what we are currently seeing; the weak US dollar is leading to greater demand from those currencies experiencing a relative strengthening which in turn is leading to price increases. When deciding to use structured products such as warrants to trade the strength of the USD currency does play a role but as I stated previously, consideration must also be given to the wider forces that affect supply and demand.
The information in this article is general in nature and does not take into account any investor’s particular objectives, financial situation or needs. In considering its appropriateness, investors should read the relevant product disclosure statement and consult a financial adviser before making an investment decision.