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Will Oil Prices Pop or Drop Post QE2?

NEW YORK ( TheStreet) -- The end of the government's second round of quantitative easing could have a significant impact on the value of the dollar and directly impact oil prices.

Schork Group Analyst Hamza Khan, who predicts longer-term weakness in oil following the end of QE2, draws a clear line between price weakness and lower prices.

"Wall Street bulls have their buying caps on and (as you can see from today's higher prices despite a catastrophic consumer confidence number) seem willing to ignore fundamentals to push prices higher," Khan said in an email on May 31.

July light sweet crude prices rose $2.11 to settle at $102.70 that day, despite a more than 5-point fall in the Conference Board's consumer confidence index to 60.8 in May from a revised reading of 66 in April. The consensus forecast was for the reading to increase further to 66.3.

Khan says investors who watched the oil price rally to almost $150 in 2008 while standing on the sidelines don't want to miss another chance at profiting from oil.

"Buying begets buying, and the end of QE2 may cause the bulls to stumble, but likely won't make them stop," said Khan.

The Federal Reserve's purchase of $600 billion in U.S. Treasuries, known as quantitative easing 2, or QE2, was designed to ensure a healthy supply of dollars on the market and helped to boost asset prices. The end of this program is expected to dry up the dollars and make way for interest rate increases, injecting strength into the currency. With oil being a dollar-denominated commodity, a stronger U.S. currency against the Japanese yen and euro, for instance, would make oil more expensive for those countries to purchase, hurting demand.

The program ends on June 30.

Khan, however, doesn't foresee the end of QE2 having an immediate, tangible effect on oil.

Many market watchers believe that QE2 has already been priced into oil, but are anticipating a rise in prices if the Federal Reserve uses language indicative of a possible QE3.

"I think the loose monetary policy will be with us for some time," says Tradition Energy's senior director of market research, Addison Armstrong, referencing the recent, poor economic data. "I think the Fed's hands are effectively tied."

On Friday, the Bureau of Labor Statistics said nonfarm payrolls increased by 54,000 on a seasonally adjusted basis in May, much lower than analysts had expected.
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