Can Oil (USO) Overcome The Dollar?

Everyone’s talking about the US Dollar and Oil (NYSE:USO).  First, the greenback is subject to our musings.

As you know, lots of people are asking a lot of questions about the USD. Will it ever stop appreciating? Will it soon correct?

What’s behind the recent rise? Can Asia survive a strong USD? Could it derail the bull market?

When is the time to flee dollar-denominated investments?

A recent survey by Bank of America/Merrill Lynch of its best clients showed that by far the biggest concern of the company’s high net worth cohort was the strong U.S. buck.

So we ask – Is there anything to this?

Have a look at action on the Euro/Dollar since New Year’s –

Euro to USD Price - Free Fall

Impressive, no?

Of course, much of the greenback’s gains against the Euro have come as the Greek predicament drew headlines, and the European Central Bank decided to go Full Monty with its own brand of Quantitative Easing (QE).

The result was vast sums of European loot searching for a haven, and finding it in good ole’ US of A.

But the truth is this – USO and the American greenback is but a side show in the great carnival that marks our times.

Side Show

And no, we’re not in for a reversal here. Nor is a stock market bust imminent.  They’ll come, to be sure. But not yet.

The move in the dollar is rather a function of a larger force in the system that’s acting as a prime mover.

Liquid Skies

The competitive debasing of currencies around the world isn’t new. The phenomenon is at least fifteen years old.

Every nation looking to buck up its exports naturally wants to see its currency lose value against the rest, since that invites more foreign purchasers to choose its goods.

But when everyone is involved in the same endeavor, you have what’s come to be known as a ‘race to the bottom’. Everyone runs his printing press, floods the world with his (cheapened) currency, and encourages the foreigner to step up and buy.

And the result is a world awash in cash of every variety – cash that has to go somewhere. It goes to purchases, investments, what have you. But it goes.

Of course, money in search of investments will naturally tend toward those locales that treat it best. And it just so happens that the United States. Despite its obvious problems, the US remains the least stained of the world’s dirty shirts, and it’s therefore accruing the lion’s share of global investment flows.

And that will not stop anytime soon.

There will be retracements on the Euro/Dollar cross, of course. But for our purposes, in the intermediate term the dollar index will gain ground and will be an important indicator for us of an eventual top-out in the equity market as well. There are a variety of other inputs that will have to be examined and integrated into our thinking, but a falling dollar will certainly be an important harbinger at the end of the bull market.

NYSE:USO and Collateral Commodity Damage

As the dollar climbs, the commodities have fallen. That’s great news for all of us who’ve been waiting to load a few tons of sugar into the garage.

But for commodities bulls, it’s plain bad news.

We’ve discussed the prospects of the precious metals at length of late, in particular gold, but at the behest of good reader George, we’re going to turn our focus elsewhere.

Ever succinct (and we thank him for that), George wrote a comment that said simply –

Got it on gold. Let’s do oil?

I salute your brevity, George. Message received. Lets do it.

We’re going to start our analysis with a simple, long term chart of the United States Oil Fund (NYSE:USO), an ETF whose value changes in line with that of NYMEX Crude futures.

This is a monthly chart, and it has some good indications for the oil bulls –

USO Monthly Chart

First up, we like the looks of the volume spike that’s transpired these last few months (in red, on right). It corresponds positively with the turnover we saw at the last bottom for oil way back in the fall of 2008.

We extrapolate from this that we’re likely in the midst of a bottom for the latest bear move.

Also, we see an RSI indicator that’s trending alarmingly close to an overbought 20 read (black square). It’s not quite there yet, but bear in mind – this is a monthly chart and it’s extremely rare to get either overbought or oversold reads. They might occur once every decade, if that.

The low RSI tells us we’ve got to be close to a bottom if we haven’t already put it in.

Let’s move now to the weekly chart for USO, where both volume and an oversold RSI tell the tale –

USO Weekly Chart

From the weekly chart we see average volumes tripling in the span of just four and a half months (in blue), while the sickly nature of the RSI indicator also becomes apparent (in black).

We emphasize that this is a weekly chart. To see an oversold weekly RSI read continue for the better part of three months is technically astounding. The selling in the crude pits was sustained and intense, and the brief snapback we saw in February was very likely the result of an equally intense bout of short covering that pulled RSI briefly out of the sub-20 oversold depths.

As of last few days action, however, when crude plumbed to new lows, we have an important read. The RSI indicator that may ‘double dip’ and slide back below the 20 line. We don’t believe this is cause for great worry, however. We also do not believe it represents additional danger of a more prolonged bout of selling.

On the contrary, we take heart from the fact that a divergence between the weekly RSI and MACD indicators on the one hand and price on the other, is now developing.

Disappearing Rigs

Let’s wrap with a brief look at a salient piece of fundamental information.

It’s a chart of the U.S. rig count, on the left hand, and production on the right.

Take a look –

Disappearing Oil Rigs

As you can see, we’ve experienced a sheer year-over-year drop in the number of operating rigs, with some 35% of the country’s less efficient and aging vertical and directional rigs closing down, while the number of shale related horizontal rigs fell by roughly 10%.

Production levels are roughly the same due to more efficiencies being squeezed out of the shale sector, but that won’t last forever.

As the rig count continues to drop and the last efficiencies are squeezed from the remaining wells, supply levels will drop, adding to price pressures.

In other words, we’re looking at an oil price rebound very soon. And here is how we’re planning to play this rebound for a nice profit…

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Options Trader Elite recommends you consider buying the USO January 17 CALL for $2.25 and selling the USO January 21 CALL for $0.94, for a total debit of $1.31 on the trade.

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Options Trader Elite recommends you consider buying the USO January 17 CALL for $2.25 and selling the USO January 21 CALL for $0.94, for a total debit of $1.31 on the trade.

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With love of the hunt,

Hugh L. O’Haynew, Normandy Research

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