Crude Oil Staging a Comeback

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 |  Includes: FXE, OIL, UDN, UUP
by: Wall Street Strategies

By Conley Turner

The trade in crude oil for the week was choppy, as the euro zone crisis weighed on investor sentiment, causing the dollar to rise versus the euro. The uncertainty regarding the outcome of local and municipal elections in Spain raised concerns about that country's willingness and ability to deal with its debts. As such, investors opted to seek out the relative safe haven of the dollar and sold the euros.

The price of oil and other commodities are typically inversely related to the value of the dollar. However, the correlation proved unstable this time around, as the commodity initially traded lower on the news but staged an impressive intraday recovery. Benchmark crude ended the week at $99.49 per barrel on the New York Mercantile Exchange on the final day of trading for the June contract. This is after settling at $98.44 on Thursday.

Also impacting the euro was the fact that Fitch Ratings reduced its credit rating on Greece to B-plus from BB+. The agency is concerned that risks surrounding Greece's ability to repay its debts had become elevated and severe austerity measures would have to be employed for the country to meet its obligations. This move effectively placed Fitch in line with the ratings that Standard & Poor's and Moody's had placed on Greece.

The dollar started to gain ground versus the euro weeks ago in the wake of comments by the European Central Bank (ECB) President Jean-Claude Trichet that there would not be any interest rate hikes in the EU anytime soon. Market participants started to sell the euro, thereby causing a decline of just below 5.0% for the month.

One other factor that impacted the price of oil was a weekly government report earlier in the week. On Wednesday, the Energy Information Agency (EIA) indicated that U.S. crude oil inventories remained unchanged in the week ended May 13. This was after a rise of 3.8 million barrels in the preceding week. The market expectation was for a build of 1.5 million barrels.

The report was a factor in causing the shift in sentiment among market participants that oil and other commodities had become oversold. Since the latter part of April, investors had locked in gains from the rally commenced in September of 2010, when the program on quantitative easing by the Federal Reserve was announced. As that program, which injected liquidity into the economy, proved to be a catalyst for higher asset prices is now coming to an end, investors opted to sell. Now it appears that the trade was overdone and they have decided to re-enter this asset class.

To this, the S&P GSCI commodities index consequently rose after having declined by about 1.6% over the previous two days. Crude oil and other commodities rose and held onto the gains amid signs that global demand remained stable. In the earlier part of that market session, the move up in oil was buoyed by the falling the dollar. However, as was the case at the end of the week, the correlation proved unstable as the rally progressed even as the value of the dollar recovered. Benchmark crude for June delivery rose 3.29% to settle at $100.10 a barrel on the New York Mercantile Exchange for that session.

Despite the near term volatility, the longer term outlook for crude demand remains upbeat, and that should be supportive of higher prices.