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Thursday, 11 August 2016
How To Profit From Correlation Between Currencies And Oil Volatility
FEATURED ARTICLE
Crude oil futures entered a steep bear market in 2014, following a multi-year trading range set into place after the 2008 economic collapse. While futures and equity buyers have lost fortunes trying to pick the bottom, many currency traders have prospered, taking advantage of tight correlation between energy futures and forex pairs that react to the sector’s high volatility. Let’s identify these correlations and how they trade, with a sharp focus on applying this knowledge to the gyrations in the crude oil market.
Given the wild price actions in 2014 and 2015, it’s likely the energy sector will carve out wide swings and multi-week trends for the next two-to-three years at a minimum, offering forex players numerous opportunities to profit. We will focus on the most popular and highly liquid pairs, with tight bid/ask spreads and easy access for U.S. currency traders. More thinly traded instruments may work as well, but they tend to carry higher costs. Most of these crosses can be found in Central and South American nations that are highly dependent on the price of crude oil. These include Brazil, Columbia, Venezuela and Mexico.
Canadian Dollar
Not surprisingly, Canadian forex crosses show tight correlation with crude oil contracts. The resource-rich nation has massive energy reserves, which strongly impact gross domestic product (GDP) and foreign trade balances. (For more, see The 5 Biggest Canadian Oil Companies.) Since crude oil is calculated in U.S. dollars, the USD/CAD pair works as a nearly perfect proxy for crude oil gyrations — both higher and lower.
This pair generates an inverse correlation since the Canadian dollar represents the denominator in the cross, advising traders to look for the pair to rally when crude oil is selling off and vice-versa. The correlation tends to ease up when precious and industrial metals are moving more forcefully than crude oil because mining produces the country’s other great source of naturalwealth.
The U.S. Oil Fund (USO), an exchange-traded equity proxy for the WTI crude oil contract, and the forex pair USD/CAD, show tightly inverse price action between the 2008 to 2009 bear market and the third quarter of 2015. The cross topped out in 2009 when crude oil pounded out a bottom and entered a two-year uptrend. In turn, USD/CAD turned lower in a perfectly inverse two-year downtrend. The instruments turned once again in 2011, with crude oil posting a recovery high, ahead of a three-year trading range.
The correlation eased up between the 2011 reversals and the 2014 breakaway trends. USD/CAD entered an uptrend during this interim period, while crude oil ground sideways, testing upper and lower boundaries. The relative detachment points out a common but poorly understood characteristic of correlation—it tends to expand during periods of rising volatility and contract when volatility eases up.
The USD/CAD uptrend escalates in June 2014 when crude oil enters a new downtrend, breaking multi-year support and heading into a test of the low posted in the prior decade. The Canadian cross responds with a rally to an 11-year high. It tends to lead the futures contract throughout this period, acting as a leading indicator for gyrations in the energy pits.
Australian Dollar
The Australian dollar cross against the U.S. dollar, trading as AUD/USD shows high correlation with crude oil as well. This appears unusual at first glance because Australia holds just 0.3% of the world’s oil reserves. However, the country has massive copper, gold, iron ire and nickel reserves that dominate its GDP, highlighting the correlation between commodity classes, especially in recent years. Electronic trading and new derivatives have tightened these relationships because broad commodity baskets can be bought or sold as risk-on or risk-off hedges in reaction to shifting sentiment in the equity and bond markets.
Crude oil and AUD/USD bottom out in unison in 2009 and enter similar uptrends that extend into historic 2011 highs that haven’t been breached in recent years. While the correlation declines between the 2011 highs and 2014, the instruments follow similar trajectories, with relative highs and lows occurring at the same time.
The instruments break down in strong downtrends in the middle of 2014. Crude oil gets cut in half during this period, whileAUD/USD drops approximately 25%. Relative highs and lows intensify correlation readings, with nearly identical price action into the second half of 2015. This lockstep behavior should ease up when crude oil begins the inevitable bottoming process, lowering volatility levels.
The percentage change differential illustrates how correlation impacts trend direction and price structure across instruments but does not predict the size of gains or losses. This is especially true when working with currencies because they exhibit price band behaviors that stretch across many decades while other instruments can, theoretically at least, rise to infinity or fall to zero.
The Bottom Line
U.S. dollar crosses with the Canadian and Australian dollars offer easy access to crude oil gyrations since both crosses show extremely tight correlation with the energy markets. This correlation has grown even stronger in the recent years, with crude oil now working through a volatile downtrend.
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Wednesday, 10 August 2016
Tuesday, 9 August 2016
Monday, 8 August 2016
Sunday, 7 August 2016
5 Things to Watch on the Economic Calendar This Coming Week
Investing.com - In the week ahead, investors will continue to focus on U.S. economic reports to gauge if the world's largest economy is strong enough to withstand a rate hike in the coming months, with Friday’s retail sales data in the spotlight.
Meanwhile, China is to release what will be closely watched trade and inflation data amid ongoing concerns over the health of the world's second biggest economy.
Elsewhere, Germany is to publish preliminary data on second quarter economic growth on Friday for further hints on the strength of the euro zone's economy.
In the U.K., traders will be eying a report on manufacturing production for fresh clarity on the health of the economy in wake of Britain’s decision to leave the European Union.
Outside the G7, traders will be awaiting a monetary policy announcement from the Reserve Bank of New Zealand on Wednesday amid growing expectations for a cut in interest rates.
Ahead of the coming week, Investing.com has compiled a list of the five biggest events on the economic calendar that are most likely to affect the markets.
1. U.S. July retail sales report
The Commerce Department will publish data on July retail sales at 12:30GMT, or 08:30AM ET, Friday. The consensus forecast is that the report will show retail sales rose 0.4% last month, after increasing 0.6% in June. Core sales are forecast to inch up 0.2%, after gaining 0.7% a month earlier.
Rising retail sales over time correlate with stronger economic growth, while weaker sales signal a declining economy. Consumer spending accounts for as much as 70% of U.S. economic growth.
2. Chinese trade data for July
China is to release July trade figures at around 02:00GMT on Monday, or 10:00PM ET, Sunday. The report is expected to show that the country’s trade surplus narrowed to $47.6 billion last month from $48.1 billion in June.
Chinese exports are forecast to have dropped 3.0% in July from a year earlier, following a decline of 4.8% a month ago, while imports are expected to slump 7.0%, after falling 8.4% in June.
On Tuesday, China is to publish reports on July consumer and producer price inflation. The data is expected to show that consumer prices rose 1.8% last month, while producer pricesare forecast to fall by 2.0%.
Additionally, the Asian nation will publish data on July industrial production, fixed asset investment and retail sales on Friday.
3. German second quarter GDP
Germany will publish a preliminary report on second quarter economic growth at 06:00GMT, or 2:00AM ET, on Friday. The euro zone's largest economy is forecast to expand 0.3% in the April-June period, slowing from growth of 0.7% in the preceding quarter.
The euro zone will release revised second quarter growth data shortly afterwards at 09:00GMT, or 05:00AM ET, Friday. An initial estimate published last week showed that the region's economy grew 0.3% in the three months ended June 30, compared to 0.6% in the first quarter.
4. June U.K. manufacturing production
The Office for National Statistics is to produce data on U.K. manufacturing production for June at 08:30GMT, or 4:30AM ET, on Tuesday, amid expectations for a decline of 0.2%.Industrial output is forecast to inch up 0.1%.
The Bank of England cut interest rates to a record-low 0.25% and launched fresh easing measures last week in a bid to buffer the economy from a downturn following the Brexit vote.
Economic activity in the U.K. is expected to slow down sharply in the second half of the year as businesses face uncertainty over the country’s future direction in wake of the U.K.'s vote to exit the European Union.
5. Reserve Bank of New Zealand rate decision
The Reserve Bank of New Zealand’s monetary policy update is due at 21:00GMT, or 5:00PM ET, on Wednesday. Most market analysts expect the central bank to cut rates by 25 basis points to a record low 2.0% in an effort to shore up the economy and boost growth.
Monday, 1 August 2016
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