Can you hear the music?

To paraphrase a song, the hills are alive with the sounds of pundits shouting that the price of crude oil is up, up, and away primarily because the dollar is way down upon a swany river. Well, this Optimist wants to sing a slightly different refrain.

Obviously, the price of crude oil is higher than a kite in flight, and at the same time, the dollar is humming the tune to the MASH theme song suicide is painless, but that does not demonstrate that crude oil strength is equal to dollar weakness. The essential question is whether the price of crude oil is pumped up more by supply and demand fundamentals, or is it elevated more by the depressed dollar that it is priced in.

You can do this with hard work . . .

So how can you separate the value of crude oil from the exchange rate of the dollar that it is priced in?  The hard way would be to track crude oil priced in each of the major world currencies (along with the respective GDP per capita, inflation rates, supply and demand data, etc. for each nation), and then to combine all of that information into a consolidated algorithm that crunches the data and produces a single world wide value for each point in time.  All of that hard work will be a good exercise for the readers. I prefer to look for simple shortcuts wherever I can find them, and there is a great shortcut I can "borrow" from that guy who calls himself an optimist.

...but I prefer the easy way to track the value of oil

Gold and silver presents an easy way to track changes in the rising real value of gold and silver over time, independently of the exchange rate of the U.S. dollar.  The basic idea is to multiply the dollar price of gold or silver times the USDX trade weighted dollar. If the dollar price of gold or silver goes up (or down) by the same percentage that the USDX dollar goes down (or up), then the product will be essentially flat, and that will show that there has been little change in the real value of either gold or silver. I call those two products the MoreAu Index and the MoreAg Index because they filter out the changing level of the USDX dollar, and directly show whether changing prices of gold and silver are caused more by changes in the value of the gold and silver, or are just reflections of currency exchange movements.

Isn't this about oil?

So what would happen if we apply that same approach to crude oil? Well, if the price of crude oil is rising primarily because the dollar exchange rate is dropping, I would expect to see the MoreOil index (the product of the two) to show not much change over time.  The actual result, however, is significantly different than that guess. The chart below shows the monthly bars of Light Crude Oil multiplied (high X high, low X low, etc.) by the monthly bars of the USDX dollar since April 1999 (which is as far back as my data source for Light Crude Oil extends).

Charts of changing value of Light Crude Oil excluding exchange rate variations

The above chart of MoreOil shows a strongly rising real value of Light Crude Oil which is independent of the exchange rate of the USDX dollar. There is obviously more happening with the rising value of crude oil than just the falling exchange rate of the dollar. My simplistic interpretation is that this steadily rising long term chart of MoreOil demonstrates that real world demand for crude oil is rising significantly faster than supply can be increased.

Some people would argue that Peak Oil is depressing the supply side of oil, and thereby causing its real world value to increase over time. Other people might say that supply is constrained (perhaps temporarily) while demand continues to accelerate. I will sidestep those arguments and present my own view for consideration. My guess is that the incredible amount of fiscal stimulation which has been injected into the economies of the world this decade has essentially turned up the heat under the world's boiler. The world economies are collectively "burning" too hot, and the rising value of crude oil is part of the increasing level of steam in the pressure cooker.  So long as the world continues to pump more heat (fiscal stimulation) into the pressure cooker of world economies, the pressure of steam created (inexorably rising prices of real materials, including oil, silver, and gold) will keep increasing at an ever speeding pace.  Eventually, an "event" or a process will occur that will turn down the heat and will allow the world economies to cool back down to a more manageable temperature. Speculating about the shape of that event or process could be the basis of an interesting future commentary. Alternatively, perhaps the far sighted politicians who zealously protect our freedoms and defend our way of life will push the government into revisiting my idea from 1979 to increase the taxes on energy use so that Americans would use energy more efficiently. Since Americans used far more energy per capita than citizens of other nations, cutting the rate that Americans used excess energy could have significantly reduced the overall world demand for energy.

Until something happens to slow the rate of increase in the rising real value of oil, however, this Optimist is confident that insulating yourself as best as you can against rising energy costs, keeping an adequate emergency supply of food and water in your personal storage, and buying silver and gold for the long term, will prove to be increasingly beneficial. Cheers!

Jim Otis, “The Optimist”

The Optimist