Which Of These Markets Is Wrong?

| About: The United (USO)

Editor's note: Originally published at tsi-blog.com on November 23, 2016

The US$ oil price and the Canadian Dollar (C$) have tracked each other closely over the past two years. When divergences have happened, they have always been eliminated within a couple of months, usually by the oil market falling into line with the currency market.

In a 25th May blog post, I wrote that an interesting divergence had developed over the preceding few weeks between these markets, with the C$ having turned downward at the beginning of May and the oil price having continued to rise. This suggested that either the currency market was wrong or the oil market was wrong. As I stated at the time, my money was on the oil market being wrong. In other words, I expected the divergence to be eliminated via a decline in the oil price.

The oil price was $49 at the time. Over the ensuing two weeks, it moved a little higher (to $51) and then dropped by 20% within the space of two months. The result was that by early August, the gap between the oil price and the C$ had been fully closed.

The oil price and the C$ then traded in line with each other for about six weeks before another divergence began to develop. Again it was the oil market showing more strength than was justified by the currency market, and by early October, it was again likely that there would be a gap-closing decline in the oil price.

As expected, there was a significant decline in the oil price from mid-October through to early November. However, the following chart shows that the gap was only partially eliminated and that a rebound in the oil price over the past 1-2 weeks has potentially set the stage for another significant gap-closing move.

I won't be surprised if the oil price trades a bit higher within the coming two weeks, but my guess is that it will drop to the $30s within the coming three months.