Did Hedge Funds Just Change The Way They Trade Oil?

Crude oil, unleaded gasoline and natural gas posted mixed results this week as volatility returned to the markets. Crude and gasoline were under pressure, while natural gas was set to move higher. Both moves were surprising because crude and gasoline momentum was trending high before abruptly turning lower and natural gas was pressing multi-month lows before making a miraculous turnaround.

The sell-off in crude oil was particularly interesting because, in my opinion, it represented a change in the trading style of the hedge funds. Having been burned several times this year aggressively playing the long side in the hopes of bullish news, this week, it looked as if hedge funds balked at a chance at buying strength that could've sent the market to a multi-month high.

Perhaps it was nervousness over the geopolitical events, or perhaps it was a change in their trading style to book a profit at the first sight of potentially bearish data. Whatever the reason behind the hedge fund selling, it now looks as if they are being more careful and likely to seek value for their next bullish play rather than try to take out resistance.

Crude Oil Analysis

The news was mixed all week, but crude oil buyers were able to overcome some of the bearish data to mount an assault on the early August high. However, surprise news on Thursday appears to be just too much for buyers take.

U.S. West Texas Intermediate posted a potentially bearish closing price reversal top on the daily chart on Thursday, on concerns of lingering global oversupply as Russia considered a future output resumption and OPEC boosted its July production numbers.

The news caught long investors by surprise because it caused some of the early in the year fears of Russia pulling out of the deal with OPEC to cut production, trim the global supply and stabilize prices to re-emerge.

According to Russian oil producer Gazprom Neft, it is "economically feasible" to resume production in mature fields after a global agreement among OPEC and non-OPEC expires, a representative of the company said.

In other news, OPEC said its oil output rose by 173,000 barrels per day (bpd) in July to 32.87 million bpd, led by the exempt producers plus top exporter Saudi Arabia.

Throughout the week crude oil gave the appearance that investors wanted to take the market higher. However, heading into Friday's action it's starting to become clear that there are still some doubts over OPEC's ability to stem production.

Inventories in the United States are at their lowest since October, having fallen for 10 of the last 12 weeks. However, that information was not enough to sustain a rally.

Additionally, investors are worried about global stocks. They remain above their longer-term averages and with the U.S. summer driving season nearly at an end, investors are well aware that the attempts by OPEC, Russia and other producers to boost prices may bring unwanted side-effects.

This week's price action suggests to me that we are still looking at a rangebound trade. This will be the result of the tug of war between OPEC and U.S. producers. It seems when OPEC tries to raise prices by cutting production, U.S. producers almost immediately ramp up production. If this continues, prices are likely to move sideways until the end of the year. The market is also likely to feel pressure if Russia even hits at boosting production.

Technical Analysis

(Click to enlarge)

The main trend is down according to the weekly swing chart. The series of lower tops and lower bottoms clearly shows the downtrend. Some traders say it's going to take a sustained move over $50.00 to turn crude oil bullish. However, this chart indicates buyers are going to have to take out $52.38 with conviction before the trend turns up.

The main range is also the range for the year, $58.36 to $42.27. Its 50% level is $50.31. This appears to be the level controlling the direction of the crude oil market. The previous week's rally stalled at $50.43. This week's rally stopped at $50.22. These moves indicate that sellers are coming in to defend $50.31. As long as this continues, the bias will be to the downside.

The intermediate range is $54.77 to $42.27. Its retracement zone is $48.52 to $50.00. The combination of $50.00 to $50.31 is proving to be solid resistance.

Crossing to the weak side of the 50% level at $48.52 will also be an indication of increasing selling pressure.

The short-term range is $42.27 to $50.43. If the selling pressure continues then its retracement zone at $46.35 to $45.39 will become the primary downside target.

Conclusion

The weekly chart indicates a wall of resistance at $50.00 to $50.31. In order to take out this area, it's going to take a combination of bullish news and hedge fund willingness to buy strength.

If the U.S. production news and the OPEC production news continue to balance then the hedge funds may start looking for value and this doesn't come in until $46.35 to $45.39.