Hedge funds jumped out of the oil market just in time.
Before West Texas Intermediate crude nosedived on Thursday, wiping out the rally driven by OPEC’s deal, money managers slashed bets on rising prices by 20 percent, according to U.S. Commodity Futures Trading Commission data. Now they may soon be well poised to start betting on the next rally.
“We are moving toward a positioning where these money managers are no longer over-invested,” Tim Evans, an analyst at Citi Futures Perspective in New York, said by telephone. “This opens up the potential for them to start buying again.”
Oil collapsed Thursday amid concerns that the Organization of Petroleum Exporting Countries has failed to ease a supply glut as U.S. shale drillers ramp up output. Shares of U.S.-based producers got crushed as investors worry they might be repeating the same pattern that led to the market crash in 2014. Earlier this year, billionaire wildcatter Harold Hamm urged colleagues to take a “measured” approach to lifting production, or risk a new glut.
In a gamble that things could get worse, about $7 million worth of options changed hands Friday that will pay off if WTI falls beneath $39 a barrel by mid-July, according to data compiled by Bloomberg.
Hedge funds decreased their net-long position, or the difference between bets on a price increase and wagers on a drop, to 203,104 futures and options in the week ended May 2, the CFTC data show. Longs fell about 7 percent, while shorts surged 37 percent, following a 26 percent jump a week earlier.
If recent history is a guide, WTI may need to dip just below $40 a barrel to form another bottom, but a bottom could already be there at close to $45, Mike McGlone, a Bloomberg Intelligence commodity strategist, said in a report. The market needs a jump in short positions, or bets that prices will fall, before it’s ready to start another rally, he said.
WTI closed at $46.22 a barrel on Friday, after dipping to $43.76.
Because short-sellers typically trade securities they don’t own, at some point they need to become buyers to return what they borrowed. They profit when they buy cheap after having sold the borrowed securities at higher prices. That’s why they end up helping in a rebound when they think prices have dropped enough, going on a buying spree called short-covering.
“The dips are to be bought,” and with so many shorts in the market, especially after Thursday’s selloff, positive news could spur a rally back into the low $50s over the near-term, Michael Tran, a commodities strategist at RBC Capital Markets in New York, said by telephone. “When you look to the second half of the year, the fundamentals do ultimately improve.”
Oil’s tumble to a five-month low was driven purely by technical trading and supply is still getting tighter, according to Citigroup Inc. and Goldman Sachs Group Inc. The current price plunge began when WTI broke through its 200-day moving average. Once that gave way, another key technical indicator called a Fibonacci retracement was breached, paving the way to the low of the year and then $45 a barrel.
In the options market, there are some signs investors might be less pessimistic than they seem following last week’s price plunge. The so-called put skew — which measures the difference in implied volatility between different types of options and serves as a barometer to risk perception in the market — traded near flat Friday even after oil’s nearly 5 percent selloff the day before.
“If there was such a radical shift in sentiment in the market, the skew would have been affected by the correction we had,” Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA in London, said by telephone. “Our view is that the market has not necessarily jumped on the bearish bandwagon just yet.”