Syncs, lags and overshoots
This is the next in a series of studies, which I’ve posted, about the correlation of oil prices and the dollar value.
The history of the dollar to oil correlation appears to me as a series of syncs, and then lags and overshoot catch up moves, by oil.
As with everything in markets, there are smaller fractals of the same phenomena embedded within larger cycles.
Let’s start with the biggest waves
20 year macro overview
- Blue box: The first blue box covers a period of 3 years, during which the dollar value plummeted, due to the increase in the money supply, caused by the borrowing the drove the housing bubble. In this phase, oil did rise while the dollar fell. It was inversely synced in direction, but lagging in amplitude.
- Pink oval: From 2005-about 2007 both the currency and the commodity went in to a balance phase. Within that, there were micro correlations. But in the big picture, they were both sideways.
- Grey box: 2007-2008 saw the big quick pop in oil, in which price almost quadrupled. Again, the dollar was synced in terms of inverse direction, but in this case it was as if oil was playing catch up, to match the wave size of the old dollar move.
And, in the process, it overshot. The dollar had fallen from 2002 -2008 by about 40%, which was, granted, a big wave. But when oil finally played catch up, it peaked about 800% above its 2002 low. So, what next?
- Cream box: Oil corrects, overshoots again. The quick correction of oil in less than one year, during 2008, was, once again, directionally synced with the dollar….but once again, the size of the move is all out of whack. So, what next?
- Lemon box: oil corrects its overshot correction. The dollar generally assists with the directions in this move, but again, oil continually overs.
- Grey oval: from 2011-2014, both products go in to a balance mode.
- White box: the 2014 move is beautifully inversely synchronized.
- Grey oval: there is a brief balance period, and then….
- Blue box: in the most recent period, oil loses sync, and falls, while the dollar does not rise out of its 2 year balance. 2 ways to look at this.
One: Oil has overshot the 2014 move in the dollar, and would likely correct, back to the grey oval.
Two: Oil’s overshoot to the down side is an attempt to correct an imbalance on a bigger time frame.
As a visual aide, let’s throw a 20 year fib on this chart, just to quickly view the middle of this whole time frame.
20 year fibs
Clearly, the dollar has returned to almost dead center on this 20 year range. Whereas oil appears to have overshot quite far to the downside.
On the other hand, overall, the dollar has spent way more time below the middle of this range, over the past 20 years….while oil, with its volatile dollar chasing overshoots, has managed to spend more time zig zagging through the middle.
One last point of note: prior to 2002, this correlation appears much less pronounced, and in some cases did not work at all, such as during 200-2001. Over all, this large time frame view appears to show an increasing synchronization between currency and commodity over time.
However, most of this is too large for me or most traders to use, in order to take positions. It is presented as broad context.
So the next step is to zoom in to the most recent two years, starting with the summer of 2014.
2 year comp
I’ve left the 20 year 50% line on as a reference. We can see that after the 2014 pop, the dollar settled in to a range, right around the middle of its 20 year range. Whereas oil initially fell, in perfect inverse synchronization with the dollar, also to near the middle of its 20 year range.
But subsequently, oil appears to have overshot to the downside.
They grey boxes are the initial range each established.
The moment when the sync broke was where I drew the blue line. Oil gapped down, apropos of nothing. The dollar floated gently in to the higher part of its range, but oil just tanked, and fell out of the bottom of its range.
In the time of the white box, the dollar did make a big up move, but still within range, which the dollar mirrored by falling further below its 20 year mid. After the white box, oil wildly overshot.
To be synchronized, oil “should” be up near that blue line. Given the tendency of oil to lag, then chase, then overshoot, we might expect a situation in which oil runs up, all out of proportion to a dollar move, perhaps overshoots the blue line on the high side, then reacts with another pendulum swing to the downside, which again goes too far, until a new equilibrium is established.
Of course, all this assumes that the dollar and oil “should” be synchronized within their respective value ranges. And that’s not a fact, just my speculation.
The way I actually use this day to day is much more of a close up. There are certainly frequently sympathy moves between the dollar and oil, on a day to day basis.
The dollar is highly coiled currently. Its chaotic movements of the past couple of years do seem to be resolving, consolidating towards a point, right near the center of its balance, on a 2 year and 20 year time frame.
So sooner or later the US Fed, or the ECB, will probably make a choice that causes a significant squirt one way or the other in the dollar, with consequences in commodities.