A cornerstone of our outlook is the conviction that oil and commodity prices are headed to much higher levels. These trends support rapid emerging market growth and the ongoing shift in the distribution of global growth away from advanced economies that began with the emergence of China in the early 2000s.
We continue to maintain that oil will rise to $60 per barrel by the end of 2017 and to $80 per barrel by the end of 2018. Our $60 per barrel projection is not only supported by statistical methods that capture recent price trends, but more importantly by the declining U.S. dollar.
A lower dollar is associated with higher oil prices. Higher oil prices are closely correlated with improving commodity prices generally. Higher commodity prices help improve emerging market economic performance —especially among commodity-sensitive emerging markets.
These patterns were somewhat interrupted by the Trump election, which sent the dollar up temporarily to a new short-term high at the end of 2016. Since that point, U.S. dollar weakness has reasserted itself with a vengeance, declining close to 10 percent through July 2017.
We are impressed with the long-term U.S. dollar cycle analysis provided by our adviser, Peter Goodburn, founding partner, WaveTrack International. In their analysis, Peter and WaveTrack show that the dollar has followed a remarkably predictable 16-year cyclical pattern since the early 1970s, punctuated with roughly eight years of general strength followed by eight years of consistent weakness. We add to this analysis the observation that each U.S. dollar peak is not as high as the previous peak and each trough is lower than the previous trough.
These long-term movements do not unfold all at once, but over several years with intermittent rebounds followed by renewed weakness. They are often associated with prolonged periods of low relative interest rates, low economic growth, and political turmoil in the United States. The long-term dollar decline and the implied rise in commodity prices and emerging markets is nicely summarized in Peter’s new blog entry, Global Opportunities, US Risks and the Grand ‘Re-Synchronisation.’
Should the dollar decline by 40 percent—roughly the long-term decline from its 2001 peak to its pre-crisis low—the trade-weighted U.S. dollar major currencies index would bottom out in the 50 to 60 index range in the 2023 timeframe (Chart 1). The dollar is at an index value of 88 today. In other words, over the next several years, the U.S. dollar could lose one-third or more of its current value.
- Note: The red line is the 187.15 month, 15.6-year cycle rhythm and projection of the US$ Dollar Index as measured from trough-trough, peak-peak with a centrally-translated mid-point of approximately 7.8-year periodicity where upswings and downswings oscillate evenly at 7.8-years. The left-scale is the US$ Dollar index price-data as sourced from the ICE exchange – the right scale is the raw logarithmic equivalent of price.
In our view, the current combination of a weak dollar and lower oil prices is not sustainable. The likelihood of a long-term pattern of dollar decline indicates that oil prices will rebound sharply before year-end. Given the dollar’s current level and long-standing correlations with oil, oil prices should already be at $54 per barrel.
We build on Peter Goodburn’s long-term dollar outlook with our own GFG trend and standard deviation analysis. The GFG statistically based approach shows whether the dollar is strong or weak relative to its trend.
We have observed frequently that the dollar value, as measured by the U.S. Dollar Major Currencies Index, is trading at very high levels relative to historical trends. Even with the close to 10 percent decline thus far in 2017, the dollar is still trading at levels that we would expect to see only 5 percent of the time.
Currency forecasting is a notoriously fraught exercise. However, we take the view that the dollar is likely to follow its post-2001 path and decline 15 percent over the next two years, reaching its trend value of 75 on the index by the end of 2018 (Chart 2).
Currency trends are not a one-way street, however. Given the precipitous decline in recent weeks, we would expect a short-term rebound as conditions and attitudes temper.
 Source: U.S. Federal Reserve Trade-Weighted Major Currencies Index 1973 = 100. Note that the Federal Reserve U.S. Dollar Major Currencies Index level and composition differ slightly from Bloomberg U.S. Dollar Spot Index. The Federal Reserve’s major currencies include only developed country currencies while Bloomberg U.S. Dollar Spot Index includes several important developing country currencies such as the Chinese renminbi, the Korean won and the Mexican peso. The Bloomberg Index is the more frequently quoted in financial markets.
Login in below to access content exclusive to clients of The GailFosler Group.
Not a client yet? For more information on the benefits of becoming a client, please contact us.