Now why should you worry about the price of oil if you’re not buying and selling oil?

If you’re neck deep into forex, there’s one good reason. Many of the most important currency trading pairs rise and fall on the price of a barrel of oil. The price of oil has been a leading indicator of the world economy for decades, and experts predict that that won’t be changing any time soon. The connection between the price of oil and the economy of many countries is based on a couple of simple facts:

1. Nations with healthy supplies of crude oil benefit economy-wise from higher oil prices.

2. States who depend on imports for their energy needs benefit from lower oil prices and lose when oil prices rise.

3. As the economy of a country is strong, its currency is also strong in the forex market.

4. As the economy in a country takes a downturn, its currency loses value in the currency exchange rate.

The ever shifting oil prices of the past few years are a good example of what can happen when factors affect the price and supply of oil. Remember from basic economy courses that higher oil prices act to put the brakes on consumer spending. This follows as long as the major source of oil for industrialized countries is petroleum based. The price of all goods produced hinges on the price of a barrel of oil. As the oil prices rise, so does production and supply prices for most consumer goods. In addition, the expenses of individual consumers rise as they pay more to fuel their automobiles and heat their homes. The net result is a downward swing in the economy of the country until it hits a rallying point that starts it back on an upward trend.

Authorities who survey the oil market are split on which way oil prices are headed, and just how far. A little over a year ago, most pundits agreed that $40 a barrel was the upper limit for a barrel of crude oil. At the beginning of 2005, oil had already broken that point, and was selling at $42.50 a barrel. The vagaries of the weather, world politics and actual capacity to meet demands have fueled one of the most volatile pricing years in recent memory. At one point, the price of crude broke $70 a barrel, an increase of 65% over the beginning of the year. And while prices dropped for a short period, at the end of the year, they were still 45% higher than at the beginning of the year. Since the turn of the year, prices have begun their climb again, and the majority of traders believe that we won’t see a reversal of that trend in the near future. The conservative predict a price of $80 per barrel. The more aggressive are calling it at $100.

What does this imply for the currency trading market?

From economics 101, we know that in the currency market, exchange rates are predicated on the health of a country’s economy. If the economy is robust and growing, the exchange rates for their currency reflect that in higher value. If the economy is faltering, the exchange rate for their currency against most other currencies also stumbles. Knowing that, the following makes sense:

1. The currency of nations that produce and export oil will rise in value.

2. The currency of nations that import most of their oil and depend on it for their exports will drop in relative value.

3. The most profitable trades will involve a country that exports oil vs. a country that depends on oil.

Based on those three points, the experts are keeping their eye on the CADJPY pairing for the most profitable trades, and here’s why.

Canada had been leaping the list of the world’s oil producers for years, and is currently the ninth largest exporter of oil worldwide. (gasp here) Since the millennium’s turn, Canada has been the largest supplier of oil to the U.S., and has been getting considerable attention from the Chinese market. It’s predicted that by 2010, China’s import needs for oil will double, and match that of the U.S. by 2030. Currently, Canada is positioned to be the largest exporter of oil to China. This puts Canada’s dollar in an excellent position from a trading perspective.

Japan, on the flip side, imports 99% of its oil. Their dependence on oil imports makes their economy especially sensitive to oil price fluctuations. If oil prices continue to rise, the price of Japanese exports will be forced to rise as well, weakening their position in the world market. Over the past year, there has been a close correlation with rises in oil prices and drops in the value of the yen.

If economy and history are to be regarded, the oil prices can’t continue to rise indefinitely. Eventually, consumers will bite the bullet and start cutting their demand for oil and gas. When that happens, the price of oil will either stabilise, or start heading back down toward the $40 a gallon that experts predicted it would never hit.