Posted by: Aaron Pressman on August 18, 2008
It’s the dog days of August and naturally an investor’s mind starts to wander to those big, unanswerable questions like what’s up with the U.S. dollar. In fact, the dollar is up and quite a bit over the past few weeks.
After peaking back in 2002, the dollar has been sliding for most of the past six years. There was a brief respite in 2005 but it’s been generally down, down, down. The Federal Reserve’s trade-weighted broad dollar index was around 130 in February, 2002. It got down below 95 in mid-July. But since hitting that 12-year low, the trend has suddenly and sharply reversed. As of Friday, the index was up to 98.7.
The sharp reversal has all manner of talking heads talking about whether the long bear market is finally over.
I’m wondering today about the question of the dollar and oil. The dollar bottom roughly coincides with the peak in oil. Coincidence? Perhaps. But there’s been an increasing correlation over the past few years between the amount of dollars flowing to OPEC and weakness in the dollar. One theory is that OPEC’s bankers have gotten increasingly bummed out about the falling value of their dollar holdings and thus have been moving to invest in things denominated in other currencies.
To test the theory with some actual data, I compared the monthly change in the dollar index to the change in the monthly dollar value of OPEC’s oil exports. If the theory is true, more dollars flowing out to OPEC should result in increased dollar selling, pushing down the value of the dollar. And that’s increasingly what happened over the past few years. In 2005, there’s a modest negative correlation of -0.39 but it rises to -0.44 in 2006 and even higher to -0.79 in 2007. If you just look at the dollar versus the euro, the correlation is even stronger, rising to 0.81 in 2007 (dollar/euro is measured in the opposite direction as the dollar index, so a positive correlation supports the OPEC dollar dumping theory for euros).
There’s only oil export data available through May, 2008, so I don’t have much for this year. The correlation has almost disappeared completely in those first few months, coming in at 0.08.
Still, there’s the strong suggestion — combined with the recent anecdotal experience — that increasing dollars going to OPEC have been a big part of the dollar’s fall and the recent drop in dollars flowing to OPEC could be helping the greenback get its groove back. What do you think? Any data you’ve seen to explain the dollar’s move?