All Hail the US "Petro-Dollar"

Thursday, 9/18/2014 09:36

Yes, the Fed's tapering helps. But here are the real reasons for the strong US Dollar...

TRYING to pick a profitable trade in the foreign exchange market is similar to judging a "reverse beauty" contest, writes Gary Dorsch, editor of the Global Money Trends newsletter.

That is to say, the winner is the least ugly currency at any given moment in time.

All paper currencies are ugly, because central bankers print vast quantities of fiat currency, to varying degrees, at the behest of the ruling political elite that appointed them to run the printing presses.

"By this means, government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft," as the late British economist John Maynard Keynes said.

In the arcane world of foreign exchange, the axiom "the trend is your friend" is a reliable piece of advice, since trends in currency pairs can extend for many months, or even years, and often lead to double-digit returns.

As such, the US Dollar Index, which measures the US currency's value against a basket of six major currencies, has suddenly risen 5% higher over the past nine weeks, to above the 84-level, marking its longest streak of weekly gains in 17 years.

Many traders are beginning to wager that the US$'s recent bout of volatility is harbinger of a longer term rally that can extend into 2015.

If the US$ index can manage to break through key horizontal resistance at the 84.50-level in the days or weeks ahead, it would signal a technical breakout to higher ground. Already, the US$ has rolled up its biggest gains against Japan's Yen, climbing 40% higher from above its all-time lows around ¥76 in the summer of 2013, to a six-year high above ¥107 in Sept '14.

The other currencies in the pack, the Euro, British Pound, Australian Dollar, Swedish Krona and Swiss Franc are also looking uglier these days, but are still gyrating within their trading ranges of the past 2 years.

Many analysts and traders were caught off guard by the US$'s recent bout of strength, but as George Orwell observed, "To see what is in front of one's nose requires a constant struggle."

The most obvious explanation for the US$'s resiliency in recent months is the Federal Reserve's gradual withdrawal from its Quantitative Easing (QE) scheme. Last year, the Fed pumped $1 trillion of excess US$ liquidity into the money markets, through its QE-3 scheme. However, at its Dec '13 meeting, the Fed switched gears, saying it would gradually withdraw from supplying monetary heroin to QE addicted markets.

The Fed has now reduced its QE-injections by $10 billion per month at each scheduled board meeting this year, to a pace of $25 billion in Sept '14. The Fed is now entering the homestretch of "Tapering" QE, and will turn-off the money spigot at the end of October, and thereby removing a major headwind for the US$.

Yet there's another less cited reason behind the recent strength of the US$ index, one which could auger the beginning of a multi-year advance for the greenback.

The US's production of crude oil has reversed years of decline thanks to the development of shale resources, which have boosted output by more than 65% in the past six years. The US's shale boom has allowed producers to unlock thousands of barrels of reserves, putting the US on course to become the largest producer of oil globally, which would dramatically reduce its dependence on imports from abroad.

US oil output averaged 8.6 million bpd in August, the highest level since July 1986. "US crude oil production will approach 10 million barrels a day (bpd) in late 2015, and will help cut US imports of fuel next year to just 21% of domestic demand, the lowest level since 1968," the EIA said. In Q1 of 2014, the US passed Saudi Arabia to become the world's largest producer of petroleum liquids, with daily output exceeding 11 million bpd, including crude oil, hydrocarbon gas liquids, and biofuels.

In fact, the US would account for 91% of the 1.3 million bpd increase in global oil output next year.

The shale revolution has enabled the US to reduce its imports of crude oil to 7.2 million bpd, or roughly -34% less from its peak in June 2005. Over the past decade, the US has reduced its imports of crude oil from Saudi Arabia, Mexico, and Venezuela, by a combined 2.9-million bpd, while increasing imports from Canada to 2.6 million bpd. With OPEC as a whole, the US's oil import bill has dropped dramatically, to $5.5 billion per month, on average, compared with its peak outlay of $24 billion in July 2008.

Until recently, the Saudi oil kingdom was able to maintain a steady flow of 1.3 million bpd to the US, even as total US oil imports fell by a third. However, Saudi Arabia is now losing market share as the shale boom leaves US-refiners with ample supplies of inexpensive domestic oil. Saudi exports of Arab light have fallen by 452,000 bpd since April to 878,000-bpd in August, the least since 2009.

Since hitting a record of almost 21 million bpd in 2005, US oil demand has fallen 10% to 18.5 million bpd in 2013, the EIA says. Fuel efficiency continues to slice away at demand, and an aging population is expected to drive less in the long run. Gasoline demand had been steadily declining since 2007 as motorists drove less and car fuel efficiency improved. New US vehicles available in showrooms are 20% more fuel-efficient on average, than vehicles introduced five years ago, according to AutoNation.

The US's shale oil revolution has helped to narrow the overall US trade deficit to $42 billion per month, on average. That's far less than the average deficit of $62 billion per month from 2005 thru mid-2008, when the US trade balance was at its worst.

The narrowing of the US trade deficit is adding an estimated +0.6% to the US's annual economic growth rate, compared with a few years ago. And looking towards the future, with the growth in world energy demand expected to increase of as much as +35% by 2030, the US economy could find itself at close to self sufficiency in energy.

So the story line for the US Petro Dollar is bound to get better in the years ahead. The US has more recoverable natural gas than any other country, the EIA says. This represents a century's worth of output and can support peak production at more than twice the 2013 level. As such, the EIA forecasts natural gas prices will average below $5 through 2023 and less than $6 until 2030.