CRUDE OIL PRICES RISE ON WEAK DOLLAR
Between the housing market decline, the weakness of the dollar, and nervous consumers,
look for crude oil to continue its rise, near term.
The housing market has had its largest decline in the past six years. With heating prices
on the rise, more people are apprehensive about the housing market. Fewer people will be
purchasing new homes over the next year. Look for the housing market to continue to
decline for the next 18 months before bottoming-out. The 25 basis-point cut in interest
rates by the Fed is an attempt to inspire consumption among Americans, especially
heading into the holiday season.
However, repeatedly cutting the rate to ensure public spending will weaken the dollar.
This is essentially the same as printing more money. Consumer spending is responsible
for 2/3 of the American economy. If the dollar is weaker and housing prices continue to
fall, the Federal Reserve may find itself in a scary situation. This leads to the crude
oil/American dollar dilemma.
Crude oil is costing more money for Americans due to international competition and the
weakening dollar. They have an inversely proportional relationship, as shown in the
chart:
With crude oil rising, the extra cost of gasoline will be filtered down to and absorbed by
the public. Normally, the winter months are when motorists receive the most relief in gas
prices. If prices are on the rise heading into the time of year when motorists travel the
least, the summer months are in line for a price increase larger than last year’s record
high.
Another adverse affect of rising crude oil prices is that people will be less willing to
spend money on gifts and travel during the holiday season. Without this stimulation to
the economy at regular prices, major airline companies and retail stores will compete by
lowering prices to inspire buying. The less money received for these products will cause
major corporations to borrow more from banks. As the Fed continues to cut rates, banks
will be able to offer more money on loan to both individuals and institutions. But this is
the equivalent of putting a band-aid on a broken leg. By making more money available
for banks to pass along to individuals and institutions, the consumers become unwilling
to spend that money on things that are not necessary, such as toys, cars and travel.
Because of the default on recent loans, banks are uneasy leaving themselves exposed to
high-risk loans.
Finally, the national debt as of October 17, 2007 is roughly 9 trillion dollars. With this
staggering amount of debt, the government has little to no money to loan to the banks to
stimulate the economy. It is a cycle that is dangerous and does not seem to have an end in
the near future.
Look for the dollar to continue its weak trend based on the uneasiness of the economy to
spend and the national debt to continue its rise. The dollar will continue its downward
trend over the following six months bottoming out around 73.500 – 74.500 (current
Dollar is 76.575). Due to this, oil prices will continue to rise. I believe the top will be
between $99-103 dollars/barrel and that this trend will continue until the end of the year.
However, I believe OPEC will increase production in January, driving the price back $9 $13. This increase in production, coupled with warmer weather in March should bring the
price back down to a manageable level.
TRADE RECOMMENDATION
Buy January Crude oil at 93.25. Hang onto crude to the target price range of $98.25 $100.45, a profit of $5,000 - $7,200. Hedge this with 86.00 March 08 puts, currently
priced at $2,500.