Don’t worry, this isn’t another fly-on–the–wall look at Kerry Katona, or Amy Winehouse and the half-dozen blokes she’s ‘made friends with’ while hubby’s been locked up. And it’s not a sporting blog on why Newcastle United just don’t get on with their managers.

I’m taking a look at one of the steadiest relationships over the past year or so, the Dollar and the oil price. The link was so damned good it was almost mechanical, the Dollar fell, the oil price rose; simple.

But over the past couple of weeks the relationship has been as rock solid as Mr and Mrs Ashley Cole’s; the Dollar’s started to feel good about itself and has been going out on its own. The third party in this ménage a trois, gold, has been happy to play its part (If the Dollar was going to be the dominant party then gold would play the weaker role). By contrast, oil has got used to all the attention and doesn’t fancy giving it up for anyone.

After three wonderful years, when the break came it was explosive; the Dollar rose 3%, but oil surged ahead, rising 11% in this month alone.

So what caused the breakdown? Have they split for good or will they be reunited sometime soon?

Go The Greenback
On April 22nd the Dollar hit an all time low of $1.60 (and a little bit) against the Euro. Since then the Greenback has gained over 4% against the Euro and 3% against a collection of other currencies (this is called the Trade-weighted Index and is an official measure of how the Dollar is doing in more general terms).

But the Dollar’s supposed to be going to Hell in a handcart, so what’s changed?

1) Firstly, and this might seem a touch premature, there’s a growing feeling that the US is over the worst of the crisis (I know, I know. I’m only giving you the word on the street). Much of the recent data has been better than the dire predictions of the soothsayers. The recent corporate reporting season passed without many howlers. OK, the banks were the financial equivalent of Derby County, but out in the real world companies were making profits. Even Beardy Ben Bernanke and his Fed wannabees hinted that the risks of a slowdown and rising inflation were more becoming more balanced. In a big nutshell, traders reckon the interest rate cycle is turning and that US rates might just have bottomed out.

2) With impeccable timing doubts about the resilience of the Eurozone economy have been creeping in. In a mirror image of the US, a lot of the economic numbers have been coming in much weaker than forecast and quite a few companies have held their hand up to finding the going tough.

3) At long, long last there has been talk of a united desire for a stronger Dollar. Thursday’s Financial Times quoted ‘senior officials’ who were pleased at the recent strength of the Dollar. The words might not be that different to previous occasions, but the timing was bang-on with traders already calling a turn in the market.

Why Isn’t Oil Playing Ball?
Over the past week oil has shown a blatant disregard for the changing fortunes of the Dollar. Granted, early Dollar strength led to a drop of $8 in the price of crude; it briefly tickling the $110 level. But this level only served as a base camp to re-group, shake out a few loose holders and steam further ahead. Each day this week has seen oil hitting a new high, reaching $124.50 late on Thursday.

I was only banging on about oil a few weeks ago (luckily I reckoned it still had further to go then). Most of the reasons for the spike in the price mentioned there (Big, Black And Everyone Wants Some) still hold true, except the link with the falling Dollar! The geopolitical worries are all still there; Nigeria, Iraq, Iran, Russia, Grangemouth. OPEC is still refusing to budge, insisting that there’s plenty of oil out there. And after all, the higher the oil price, the more cash available for the Middle-Eastern sovereign wealth funds. Expect more cash injections into the West’s favourite companies.

One new factor is the same one helping to drive the Dollar. The very confidence in the US that’s pushing the Dollar higher is also giving the oil price a hefty push (if the US economy isn’t really weakening then it’ll be needing more oil than previously thought).

Hubble Bubble Oil And Trouble
The persistent rise in the black stuff has been begging the question, “Is it all a big oily bubble?”

First, let’s nip back to the classroom to check what we’re dealing with. There’s a whole washing machine of bubbles out there; speculative bubbles, economic bubbles, market bubbles, they’re all pretty much the same thing, which is “trade in high volumes at prices that are considerably at variance from intrinsic values.”

OK, as far as volumes go, check out the chart below. See how the volume has almost doubled over the past year.

As for value, who am I, JR Ewing? I don’t know, but I read a report today estimating the marginal cost of production as around $70 a barrel, about as close to the current price as Gordon Brown is to getting re-elected. I can’t argue with recent forecasts that oil could reach $200 a barrel over the next 6-24 months. After the rise from $40 in 2004 who really knows? But to me those sort of crazy figures flash an amber warning on the bubble-ometer.

Trends Reunited?
So what’s the likelihood of these two trends getting back together?

The possibility of an oily bubble is discussed above. At the very least the distance of the current price from its 21-day moving average suggests the need for a correction. So there’s a chance of a trial reconciliation.

The biggest risk to the Dollar is the high-octane level of confidence in the markets at the moment. It might be too strong to suggest that some of the recent economic numbers were manipulated. However, some fanciful assumptions were used in calculating both the GDP and employment numbers. These could return to haunt the market in the near future.

The relatives might get involved:
Looking at the relatives might restore the relationship. There’s a feeling that if the US does slide back into something nasty then Europe, and perhaps the UK, could end up in an equally messy situation. The level of the Dollar has been allowing for more of a slowdown than most other currencies. With US rates already scraping the floor at 2%, the Dollar could strengthen as other currencies allow for the possibility of lower rates. The case for a fall in the oil price should be more clear-cut if a recession spreads across the developed world.

My Call?
I’ll tell you one thing; I’m not going to mess around with oil. It might well be in bubble territory, but it’s also on growth hormones. I don’t trade the commodity markets, but if I did I wouldn’t try fighting a trend like the oil price. But neither would I be buying it on the basis of a few crazy predictions.

I much prefer trading the Dollar. Trading intraday leaves room to pick out moves in either direction. It’s too early to tell yet if this is the start of a major bull run in the Dollar. Checkout the EURUSD chart below:

After the rise since last August the current Dollar move might be no more than a healthy correction. The 12-day and 21-day moving averages have turned down, lending credibility to a change in trend. But the 100-day moving average has provided good support on the way up. The Dollar will have to break below that, at around $1.5150, and further support at $1.50 before traders take it too seriously.

At the moment I’m looking to sell rallies in EURUSD and GBPUSD, and keep my foot off the gas when I’m driving.