All eyes are on the dollar

Institutional investors are becoming increasingly concerned that the dollar will weaken more in the quarters ahead, due to the large U.S. budget deficit. A weaker dollar deceases the value of dollar-denominated investments, hence the big guns are piling into oil. Oil will face psychological resistance at $80 per barrel, but beyond that it's relatively smooth sailing, from a technical standpoint, to $90.

The irony, of course, is that oil is priced in dollars, but investors compensate for this by simply pushing the price of crude up even more. True, oil is not as strong an inflation/currency deprecation hedge as gold is, but it's close: the vitalness of crude to the global economy has given the commodity a special status, particularly in the last 35 years. When dollar woes, for fiscal or monetary reasons, start to roil the markets, institutional investors pile in to oil futures, short-term, if not for longer plays: the position usually works out well.

The latest tailwind for oil involves a likely $2 trillion increase in the 10-year U.S. budget deficit estimate, to about $9 trillion. That would be more than enough to get jittery institutionals hitting the oil 'Buy' button in a big way, most likely pushing oil well over $80.

Longer-term, 3-6 quarters out, oil's price will be determined by the shape of the global recovery, particularly in oil-hungry emerging markets. If Asia grows slower than expected in Q3/Q4, that will slow oil's rise; if GDP performance shows an impressive recovery, oil will head for $90 and beyond.

Financial Editor Joseph Lazzaro is based in New York.