If I had a strong dollar for every time ...

The only thing we seem to know for sure about the parabolic rise in the price of oil is that there are various forces at work that are not easily transparent, and those dots that are discernible aren't confidently connected.

Guambat reckons that these forces are always at work in one form or other, but that we are in a time of "perfect storm" conditions, or quantum mechanics, or something, that conspires without scienter to bring about unexpected, and some nasty, circumstances (in the vernacular of the day, a "black swan").

Guambat's prejudice, and let's call it for what it is, is a "big oil" effect (see, e.g., here and here).

Another conspiracy theory centers on the speculation about speculators. For instance, see the commentary from WSJ's David Weidner in this post.

The speculator conspiracy also resonates with Guambat, because his tuning fork is pitched to the nefarious ways of fast money, e.g., this and this. Along that thought-wave, but on a parallel track that doesn't impute mens rea, John Mauldin recently made some interesting observations.

I have been pondering for a few weeks about whether the long-only commodity index funds are really affecting the markets. Basically, these funds have become a huge part of the commodities market. It is clear that enough buying and in size will affect any market, but these funds do not take delivery. They "roll" their exposure as they get close to expiration, so they are not involved in the spot price. In theory, the spot price should be a function of immediate supply and demand.

Looking at recent CFTC data, investors known as "commercials" were long 827 million barrels of oil. In the early part of the decade it was 3-400 million barrels. Commercials are supposed to be those who are hedging their production of oil. But large oil companies rarely hedge, and smaller producers only hedge a portion of their oil.

Where is the increase in commercial interest coming from? The clear answer is long-only commodity index funds and ETFs. They simply buy baskets of commodities at whatever the price is, speculating on the rise in the price of the overall commodity market. It is a one-way trade.

But there are limits to how much exposure speculators can buy, because the CFTC will allow a speculator to only buy so much of any given market, to keep large players from getting a corner on the market and driving up prices, a la the Hunt brothers and silver in 1980. These limits are known as "position limits."

There are no position limits for commercials who are hedging. They are in theory hedging their physical exposure to a given commodity they are selling or buying. Think of a farmer and General Mills. Both want to lock in the price of wheat so they can plan for the future. Speculators are useful in that they provide liquidity to the markets. In fact, they are essential to a properly functioning market.

The CFTC created a loophole when they allowed investment banks to be classified as commercial investors. So, when a long-only commodity index fund wants to buy a million barrels of oil, they can go to the investment bank, who will sell them a "swap" on the price of oil, and then immediately hedge their exposure in the futures market.

To be sure, the long-only index fund can now create positions far in excess of the position limits that are enforced upon normal speculators. These funds can grow to be huge - multi-tens of billions of dollars. Even though they are speculators, they are not included in the data as speculators. Because they get their exposure from an investment bank, they are ultimately listed as a commercial. In total, they represent an enormous part of the commodities markets. But they are providing liquidity, so what's the problem? They are not actually hoarding the commodities. The price is still set at the spot price. But.

But that is not the whole story. They are making it difficult, if not dangerous, to short the market. When massive buying comes into the market, it moves the market and sends the signal to the market that prices are rising. Momentum players move in, and prices rise some more.

In fact, as the price of oil has risen from $90 to $100 and higher, normal speculative open interest has declined, as who can afford to fight the tape? At the least, I expect the CFTC to require those "commercials" that are really long-only index funds to provide transparency.

In that same piece, Mauldin also mentions that there is a currency connection to the rising oil prices:

there is a real connection between the price of dollar and the price of oil. In dollar terms, oil rises as the dollar falls and vice versa. The weak dollar policy that this country has had (in spite of denials) is having an effect.

Guambat has previously noted that the supposed link between currency and commodity occasionally disconnects.

David Gaffen, in WSJ's MarketBeat today, reminds us that the "connection" between currency and commodity (as with so many other perceived "linkages") is not necessarily cause but only correlation.

These days when traders see the daily changes of crude oil, more than likely the first factor cited is whatever the dollar happens to be doing on that particular day.

Some have made reference to a “short the dollar, long commodities” trade in the market, and indeed last week’s frenzied rise in oil prices seemed to be triggered by a rally in the euro against the dollar....

But as the saying goes, there is a difference between correlation and causation, and those who are hoping for renewed strength in the dollar in coming months as a way to take the pressure off of commodity prices may be in for a surprise.

Marc Chandler, head of currency strategy at Brown Brothers Harriman, says that the weekly percentage change in crude oil was correlated with the change in the euro against the dollar about 20% of the time for the past five years.

That’s not that high — better than a totally random relationship, but hardly conjoined twins. . But over the past six months, the daily change has correlated 40% of the time, and for the past three months, 57% of the time.

So what traders are seeing anecdotally is indeed true — the dollar’s daily movements against the euro has been at odds with oil’s movements 57% of the time, a reasonably high level of common movement. Such analysis becomes self-fulfilling at times: witness Friday’s fall-off in the dollar and the $10.75-rise in crude oil, set off by Mr. Trichet.

“Trader behavior has been…the dollar weakens and crude becomes a dollar hedge of choice,” says Howard Simons, analyst at Bianco Research LLC. “If you want to fight that trade, they’ll let you, but you’ll lose money.”

But Mr. Chandler says the recent correlation is “a fluke,” saying that while the added volatility in currency markets may be exacerbating movements in crude oil, investors in the two markets aren’t necessarily keying off each other. He says worries about U.S. economic growth remain the paramount concern in the currency markets for those selling dollars, and crude oil continues to rise because of world-wide demand.

“You need to be careful with this,” Mr. Chandler says. “There’s a very strong correlation between the number of churches in a city and the number of mortuaries, but it doesn’t mean there’s a causal relationship.”