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Peso’s Message For Crude Oil

Chart In Focus
August 07, 2015

I confess that I am not a “currencies guy”, but watching the currencies can be terribly interesting because of the fascinating correlations to other price series.  The chart above looks at the price of crude oil in the U.S. and the exchange rate of the Mexican peso to the U.S. dollar.  Mexico is a net exporter of crude oil, and so it is not surprising that there should be a correlation between how crude oil prices are doing and how the value of the peso does.  What may be surprising is just how good that correlation is.

Right now we are seeing a lower value of the peso than we have seen in many years.  That is great if you are planning a trip to Cabo San Lucas.  It is not so good if you are a U.S. manufacturer trying to sell products into Mexico, where the people have currency that is not as valuable as it once was. 

Before I veer off too far into a geopolitical debate, I want to make the point that I am introducing the correlation between oil and the peso for ulterior motives.  I have noted in the past how the Commitment of Traders data for crude oil futures has grown to be problematic as a sentiment indicator.  Here is a chart to show what I am talking about:

crude oil commitment of traders

It used to be that the commercial traders of crude oil futures would oscillate back and forth between net long and net short in equal measure.  And when they did, it made for some great indications of tops and bottoms for crude oil prices.

But now we are seeing that the commercial traders of crude oil futures have been staying net short continuously since 2009.  It has stopped being a reliable sentiment indicator.  The best one can say is that it sort of moves up and down along with prices, and when it moves too much then maybe that indicates a top or a bottom.  That’s far from being a compelling message. 

The fun insight comes when we realize that the strong correlation between the Mexican peso (and the Canadian dollar) to crude oil is an opportunity to gain insights.  The COT data for the peso and the CAN$ are useful proxies for what crude oil prices should do, and that is especially true when they come into agreement.  Here is what I mean:

crude oil with Mexican peso and Canadian dollar COT data

The commercial traders for both the Mexican peso and the Canadian dollar are at a multi-year record net long position.  In other words, the smart money believes that these two oil-correlated currencies are going to be headed higher.  For that to happen, oil prices should presumably also head higher, or else the strong correlation would have to break. 

The commercial traders of Canadian dollar futures (the green black line) have been more consistently bullish, staying net long most of the time.  Maybe someday they will be rewarded for that faithfulness.  What is new right now is that the commercial traders of Mexican peso futures (the black green line) are now joining in that assessment in a big way.   The implication is that both currencies should be headed higher in the weeks and months to follow, and also that crude oil should follow suit.  We will be reporting on the actual results for what crude oil does in our subscription publications.

The peso may not be all that valuable today as a currency to buy dollar-denominated “stuff” with.  But it is wonderfully valuable in other ways, especially as a proxy indicator for telling us where crude oil prices can be headed.

Tom McClellan
Editor, The McClellan Market Report

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