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Will Hedge Funds Drive Oil Prices Even Lower?

Oil Barrels

Andurand Capital reportedly liquidated all of its bullish bets on crude oil in recent days after posting steep losses so far this year. The fund is led by Pierre Andurand, who became notable after correctly predicting the oil price spike in 2008, so the market tends to closely watch what his hedge fund does on oil.

Despite its past success at predicting major oil price movements, Andurand Capital was burnt by crude this year. They predicted oil would hit $60 per barrel at the end of last year and rise to $70 per barrel by this summer. As a result of that overly-optimistic positioning, the hedge fund lost 15.4 percent between January and April on bullish bets that went sour, according to Reuters. In late April, Andurand decided to cut its losses and close out its positions, a sign that the oil bulls are retreating.

In fact, the recent losses in crude prices have the bears on the march. For the week ending on May 2, hedge funds slashed their bullish bets on oil futures yet again, taking their overall net-long positioning to its lowest level since the OPEC deal was announced in November 2016.

A further reduction of long bets and buildup of shorts is likely, but some traders could be late to the party. While hedge funds staking out the most bearish position in six months certainly tells a story of negative sentiment throughout the market, it also reduces the future downside risk to oil. If a lot of bullishness has already been squeezed out, there is less built up pressure to push prices down further. Put another way, there is a lot more room now on the upside since everyone got out of their bullish bets. “We are moving toward a positioning where these money managers are no longer over-invested,” Tim Evans, an analyst at Citi Futures Perspective, told Bloomberg. “This opens up the potential for them to start buying again.” Related: Four Charts That Explain OPEC’s Fall From Power

In one of the more striking trading developments, Bloomberg reported that last Friday, the day after the 5 percent plunge in oil prices, the volume of bets on crude prices falling to $39 per barrel surged. Roughly $7 million worth of options were sold, options that pay off if WTI dips to $39 by mid-July. And the volume of options on $39 oil by August surged to 20 times their normal trading activity. In other words, a lot of people are putting money on the line, betting that WTI goes below $40 per barrel in the next few months.

But again, while that is entirely possible, the herd risks taking things too far. Some view the spike in bearish bets as a sign that negative sentiment is no longer contrarian, foreshadowing a bounce back in prices. “That’s just a huge speculative bet that tells me that the fear is at its heights and we’ll probably see oil recover," James Cordier, founder of investment firm Optionsellers.com, told Bloomberg, in response to the $39 options. “It’s a hell of a lottery ticket that the market’s going to keep falling."

Yet another way of viewing the recent selloff through a bullish lens is that short-sellers need to cover their shorts, so they buy on the price dips. As they buy up positions on those low points, they tend to contribute to a bottoming out and a rebound. Short-covering can create a new resistance level – perhaps at $45 per barrel, for example. So, selloffs often lead to rebounds.

Goldman Sachs and Citigroup argue that the 5 percent plunge in prices last week can be chalked up to technical trading – once the 200-day moving average was broken, a steeper selloff ensued, breaking through more key resistance levels. However, the sharp move down – more than 7 percent in less than a few days – occurred even as very few headlines or new data suggested a shift in the fundamentals. That is why Goldman and Citi tried to reassure their clients, telling everyone to keep their eye on what really matters, which is the supply/demand balance. The supply surplus has taken longer than excepted to move back to balance, but the investment banks insist the adjustment is on track and ongoing. As the surplus steadily narrows, oil prices should firm up.

By Nick Cunningham of Oilprice.com

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