Oil-Linked Currencies Poised for Rise
March 24, 2011
With Japan's demand for oil expected to increase as the nation rebuilds from its devastating earthquake, and while geopolitical risks in the Middle East and North Africa remain at the forefront of global worries, oil-and-gas-sensitive currencies could reap the benefits of robust crude-oil prices in coming months.
After the magnitude-9.0 earthquake and tsunami knocked out nearly a quarter of Japan's refining and nuclear-power capacity, Japan's demand for oil and liquid natural gas will likely increase to fuel power generators along with the reconstruction process, analysts said.
"Most seem to think that there will be a stimulative impact for oil prices just based on initially the need for fuel [in Japan] in terms of generator power, but secondly the need for rebuilding and how that is a fairly oil-intensive process," said Camilla Sutton, chief currency strategist with Scotia Capital.
In addition, markets are now approaching peak season for oil demand, with North American and European consumers jumping back into their cars as winter wanes and vacation-time approaches. All the while, the situation in Libya and elsewhere in the Middle East and North Africa remains fluid, and, according to a research note from Barclays Capital analyst Amrita Sen, Libya seems to have likely entered "a prolonged period of political and economic evolution with a significantly reduced capacity to export energy."
"[A] lot of people may well be surprised by where oil prices are by August or September this year," said Adam Myers, foreign-exchange strategist with Credit Agricole CIB in London.
This trend will, in turn, push up the currencies of oil-and-gas-exporting countries, such as Canada, Norway, Russia, and Australia, analysts said. Although Australia exports very little oil, it has huge natural-gas reserves and a rapidly growing liquefied natural gas, or LNG, operation. Demand for its huge store of high-grade iron ore is also likely to be boosted by Japanese reconstruction needs.
Analysts note that buying these energy and commodity-linked currencies is a way to hedge against the damage done to other currencies by high energy costs and rising inflation.
Scotia Capital's Sutton highlighted Norway as an especially pure oil play, noting that it has a strong sovereign position and vast oil reserves, and isn't as dependent on the Asian growth story to the extent that Australia is. Investors can be long krone versus the dollar for a better return profile, or long krone against the euro for a better risk profile, she said.
Given the instabilities in the Middle East, investors looking to hedge against oil inflation might want to trade oil-exporting currencies of stable and well-governed countries that are far from that region, rather than expose themselves to that region directly, Myers said.
He recommended purchasing a three-month liquid-currency, oil-exporter currency basket--made up of the Norwegian krone, Canadian dollar and Russian ruble--against the Japanese yen. The yen is the ideal short-sell, as Japan imports nearly all the oil it consumes, he said, adding that such a trade would go into midsummer, at which point investors can take stock of oil demand and geopolitical risks.
"One way to get the diversification in terms of your portfolio, but still have that commodity-inflation exposure, is to expose yourself to those currencies," he added.
Ian Naismith, who actively manages the Florida-based Currency Strategies Fund, which has about$22 million in assets, said to watch the performance of the dollar index and European currencies. If those currencies are being moved flatter in coming months, then he will likely increase the fund's exposure to oil- and commodity-linked currencies, particularly the Canadian and Australian dollars, he said. The fund already has exposure to those two currencies, he added.
Still, there is some downside risk to these approaches, the primary one being a sudden turnaround in the Middle East and North Africa upheaval, with Libya and other embattled nations in the regions finding fast and peaceful resolutions.
"If the Middle East works out their issues and they put a nice big bow on it and it just goes away, then oil's going to drop 10 bucks, maybe even more," said Rich Ilczyszyn, senior market strategist at Lind-Waldock in Chicago.
In addition, in the case of Japan, markets have yet to see what the rebuilding process will look like and what it will require.
"We really have to still see what is going to transpire in Japan, and we're still in the early stages," Scotia Capital's Sutton said.
Source: Dow Jones Newswires
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