Basics

The correlation between Oil and Forex


One recurrent question in the market is if there is a correlation between the price of oil and forex. If you do a quick search on the Internet, you will find many explanations and graphs showing proof of oil prices closely following the price of certain forex pairs.

As a formally educated economist, my standpoint is that there is no strong scientific evidence of this correlation. However, there’s an explanation of the market sentiment of price correlation for oil and forex pairs.

For example, petroleum oil is a very important energy commodity in the world economy since the start of the industrial revolution. Because of its role as a primary energy source in many industrial applications, and as an asset in financial markets, oil is also a driver of political power, beyond exploration and natural resources.

Therefore, every nation who wants to secure a strong economic and political position in international theater must have control of enough sources of petroleum oil.

petroleum oil and its importance to world economy

In parallel, the United States establishes a long hegemony in the world market, using the US dollar as a strategic tool of influence in other economies. Since the Bretton Woods Agreement in 1944, and the subsequent floating of exchange rates for the first time, the US dollar is the standard currency for international trade in the forex market.

Forex and oil prices

Considering that major petroleum producers convert their resources to US dollars to manage their stock inventory, this exchange pair became known as petrodollars. So, there is a connection between oil and currencies like the US Dollar. The importance of country producers of oil creates a very close relationship with major economies of the world.

There are many economic and geo-political events that can affect the US dollar and oil that occur at the same time. And while such events may have the same causes, they don’t always have a direct relation between each other.

An example is when George W. Bush started a war in the Middle East, it pressured the American budget with more military expenses. At the same time, such actions send a signal of new potential tax increase or higher interest rates increases to cover new military expenses.

Considering that a declaration of war is normally not good for international trade relations, it can trigger worse expectations from global investors. As a result, a decrease in risk tolerance worldwide can follow and have a negative impact on growth in the world economy.

Conversely, currencies such as the US dollar are a standard of international trade, and in times of market uncertainty, investors flock to buy safe haven assets such as the US dollars, which causes its price to increase.

In parallel, once the theater of war is placed in a specific country or region, for producers of petroleum there can be an immediate expectation of shortage in oil supply. Such events that reduce supply can cause a price spike for oil in international commodity markets.

Analyzing forex and oil prices

Below is a chart screenshot with the price of the USD/CAD relative to the price of Oil, which appear to move closely in the same direction at the same time. Because these assets were affected by the same causal events, does not mean these are necessarily correlated. In other words, knowing how oil will vary in the future, doesn’t mean you can predict how forex prices will behave.

The conclusion is that it is more recommended to be cautious and monitor separately the factors that cause oil prices to change, versus changes to forex prices. Just because sometimes they vary in the same direction does not guarantee that they will always vary in the same direction. Learning is a process and education is hearing a second opinion.

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Takeaways

  • There is no strong scientific evidence of correlation between oil and forex prices, but they share some of the same fundamental drivers that make them often vary in the same direction.
  • If you want to operate in both markets, then monitor each one independently. If you don’t have time enough to do so yourself, Wiseinvest can provide trading signals through our Wise AI forex trading system service.

“The stone age did not end because the world ran out of stones, and the oil age will not end because we run out of oil.” (Don Huberts, 1999). It will end because Artificial Intelligence will show us more profitable ways to invest.

Disclaimer: Forex and Contracts for Difference (CFDs) are complex instruments and come with a high risk of losing money due to leverage. Forex trading is not suitable for everyone. You should consider whether you understand how forex and CFDs work and whether you can afford to take the high risk of losing your money.

The forex brokerages displayed shall disclaim the overall performance of traders in their platforms. Oanda warns that 76.8% of retail forex traders lose money trading CFDs. XTB warns that 80% of retail forex traders lose money trading CFDs. The forex broker Fxcm warns that 69.66% of retail forex traders lose money trading CFDs.

The performances aforementioned are not related to Wiseinvest AI forex trading and AI forex signals system. You can check the performance of our AI forex system on our dashboard.