The Correlation Between Oil Prices And The Forex Market

by Team Dinks on September 25, 2015 · 0 comments

oil-106913_1280The recent slump in crude oil prices, down to $40 per barrel of Brent Crude Oil, has once again placed the spotlight on the price of this essential commodity. Once described as being in massively short supply, analysts now point to a glut of oil, driven in part by China’s slowing growth, and a number of analysts and commodity experts have even said that they expect the price of oil, which was only recently quoted at $105 per barrel, to fall as low as $20 per barrel.

While it is likely that the price will rebound, either as governments look to stockpile their own supply or should the Chinese economy bounce back to its former glory, it gives investors and novice analysts the opportunity to further investigate the correlations that exist between oil prices and the forex market, as well as other investment markets.

China’s Economy And Oil Prices

There are, in fact, many possible correlations between oil and exchange rates. It is relatively easy to see how oil prices might be affected by China’s poorer than expected financial performance. They are the world’s largest net importer and the world’s largest buyer of oil.

Supply And Demand

They have been busy stockpiling the resource for years, fuelled by 10% average annual growth rates, and as they have continued to buy more and more, it means that demand has been high while supply levels have diminished. In an open market, high demand and low supply equals rising prices. More recently, however, growth rates have fallen below expectations, below previous levels, and even below adjusted forecasts.

As a result, the country has not had the money to invest in its oil stockpile. Demand has reduced, and supply has reduced. Concerns over further economic problems, and the possibility that China could flood the market by selling its own stock of oil, mean that investors are selling oil futures in a bid to try and protect the capital that they still have. This has all added up to considerably lower oil prices.

Oil Prices

Since July, crude oil has dropped from around $100 per barrel to less than $50 per barrel. Furthermore, analysts have pointed to a continued trend that indicates prices will fall even further. While some resistance is expected, analysts have set a $20 target price.

The strong correlation between the Chinese market and crude oil prices could be witnessed first-hand at the end of August. The stock market suffered considerable decline over the period of a few days, falling by a record 9% on August 24th. Seemingly in direct response to this, the crude oil prices fell by 6% on August 25th, showing that crude oil prices are directly affected by the performance of one of the world’s largest economies that has become so reliant on buying up large stocks of oil.

The Implications

The most obvious implication of this drop in oil prices is for mining, exploration, and oil related businesses. Those involved in the discovery and production of oil are likely to see their stock reduce in price, while those that have a heavy reliance on buying and using oil will have lower material costs so could see an increase in their stock value, if analyst predictions prove to be correct.

On a grander scale, it isn’t just individual companies or even market sectors that are affected by oil prices. Some of the world’s economies are intrinsically linked to oil prices, and sharp movements in either direction have a massive effect on those economies and their countries. Russia, Saudi Arabia, and other oil producing countries will suffer as a result of their primary export being devalued.

Winners And Losers

Countries that are net exporters will suffer the most. A net exporter is a country where the value of its exported goods outweigh the cost of imported goods. Canada is considered one of the world’s largest oil net exporters, and this means that their economy will suffer if the price of oil continues to drop and devalue.

At the other end of the scale are countries like Japan. They are net importers, so the value of imports outweighs the value of their exports, and with crude oil at a fraction of the price it was just weeks ago, Japan has the upper hand because they can purchase an essential commodity at a much lower price. The Japanese economy is likely to benefit, Japanese companies should see greater profit, and the Japanese Yen will strengthen against other currencies.

Continued Concerns Over Crude Oil Prices

Concerns remain over the crude oil price. Summer demand is nearly over and refineries are undergoing maintenance. The slowdown in global economies in Europe and Japan as well as in China also means that demand could reduce even further than the typical, expected seasonal shift, and if this is the case then it could mean a major sell-off, only further flooding the market with unwanted and unnecessary supplies of the commodity. It is this sell-off that could lead to the lowest oil prices in recent history, and that economists fear could further deepen the woes of many economies around the world.

Investors And Opportunities

For the investor, utilizing platforms like ETX Capital to profit from the market volatility that is bound to ensue, there are considerable opportunities present in the commodities market, but also in foreign exchange and stock markets around the world.

Trading Exchange Rates

There are many factors that govern exchange rates, and there are many correlations that exist between the various trading markets that exist. Inflation rates, GDP, and manufacturing output rates, as well as commodity prices, and even political relationships between countries are all factors.

Oil is such an important commodity to so many economies, and is so closely linked to some of the biggest economies in the world, that it has a clear and direct relationship on many factors other than crude oil prices. The alert investor always has one eye on commodity prices, in order to ensure that they are one step ahead of major global changes.

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