Oil price link to U.S. dollar strongest in 14 months

SINGAPORE Tue Oct 26, 2010 1:56am EDT

SINGAPORE (Reuters) - Oil prices are more dependent on dollar fluctuations than at any time in the last 14 months as speculation intensifies that the U.S. Federal Reserve will embark on a fresh round of monetary stimulus to boost recovery.

The inverse correlation between U.S. crude and a gauge of the greenback's value against a basket of major currencies .DXY on Tuesday reached its highest since August 24, 2009, data compiled by Reuters showed.

For a graphic: here

Oil stocks at top consumer the United States have come off record highs earlier this year, while soaring demand from emerging economies is helping drain a persistent surplus. But the dynamics of traditional supply and demand factors are being overshadowed as the effect of currency flows prevails, with prices stuck between $70 and $85 for most of 2010.

"Oil in itself is treated as an investor asset, rather than a consumption asset or a physical good," said Serene Lim, a Singapore-based oil analyst at ANZ.

"With excess liquidity expected to come into the market, it's a commodities play as part of a riskier asset class."

Correlation can show how related price changes of two assets are to one another, and is measured in a scale from minus one to plus one. A value of zero indicates no link, while the closer a reading gets to the extremes, the stronger the correlation, inverse if negative and direct if positive.

An inverse correlation means the two variables move in opposite directions, while a direct correlation implies they move in tandem.

Oil is most often inversely correlated with the dollar because a stronger U.S. currency hurts the purchasing power of holders of other currencies, while a weaker greenback renders oil imports of the dollar-denominated commodity cheaper for them.

The inverse correlation between U.S. crude and the dollar measured against the currency basket jumped to -0.7522 on Tuesday from -0.6105 a day earlier, when the dollar tumbled to a 15-year low against the yen.

It reached a record -0.7885 on November 4, 2008, as oil was plummeting from almost $150 a barrel in July of that year to less than $35 by December. Over that period, governments around the world orchestrated the biggest monetary stimulus of all times in an attempt to fend off the deepest recession of the post-war era. In a mirror image of oil's inverse correlation with the dollar, the direct correlation between U.S. crude and the euro is now at its highest since March, after a weekend Group of 20 meeting that produced no firm policy initiatives reassured investors that market trends would remain unchanged.

(Editing by Manash Goswami)

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