USDCAD: With Oil Goes The CAD

Includes: CRUD, FXC, SPY, USO
by: Sean Bellamy McNulty

The shift out of commodities continues in what I suspect will be a longer term trend. Of note as of late is the divergence between oil and the S&P500. This relationship has held since 2009, where a rise in the S&P500 equated to a rise in oil prices.

(Click to enlarge)

Source: Business Insider

This relationship acted as a cap on SPY rallies, as increases in oil prices have corresponded closely to downturns in the economy. Recessions in 1973-1974, 1979-1981, 1990-1991 and 2000-2001 all had this feature. Therefore, the breakdown of this relationship is another development in favor of a continued SPY rally.

For the FOREX markets, there are important implications of this new relationship between a higher stock market and lower oil prices, namely lower prices in the USDCAD exchange rate. This relationship hasn't broken down as of late, and over the past 5 years the rise in oil has corresponded with a rise in the CAD. The peak in oil prices was May 2nd, 2011, which was followed by a peak in the CAD a few months later on July 26th.

In addition, their correlation has been overwhelmingly negative, with periodic decreases in correlation caused by independent events in either oil or the CAD.

The chart below demonstrates this. The top chart is the USDCAD exchange rate, the middle chart is light sweet oil futures and the bottom chart is the correlation over 20 trading days, or one month. The charts are all over a 5 year time interval.

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In the short term this relationship also rings true. Just today (May 15th), the intraday reversal in the CAD was followed closely by a rally in oil futures.

(Click to enlarge)


The divergence of the SPY and oil creates a heads oil goes down, tails oil goes down situation, and if oil falls while SPY is rallying, oil prices are sure to take a hit if the SPY has a pullback. As I outlined in an article published yesterday, I see little fundamental reasons why Western Texas Oil prices will stay above $90. Of course, any geopolitical events could be seen as a potential catalyst, but despite plausible story lines for potential world conflicts, in probabilistic terms these types of events are rare. This makes for a favorable risk to reward scenario in shorting oil, and thus shorting the CAD.

There is a slew of U.S. and Canadian data to hit the tape with the potential to upset this relationship as the week finishes, especially the Canadian Consumer Price Index numbers published Friday at 5:30am Pacific Standard Time. Outside of these idiosyncratic risks, the direction of oil will be indicative of the direction of the CAD.

Disclosure: I am short USO, FXC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I am actively trading the FOREX market and may be either long or short the currencies discussed at the time of this article's publication.