Hedge Funds Impacted, also Affecting Oil Slide

Hedge funds have been badly wrong-footed by the slide in oil prices over the past five months, and by trying to turn their positions around have accelerated the rout.

Going into the summer, hedge funds and other money managers had amassed one of the largest bullish positions on oil prices on record.

By the middle of June, hedge funds had a net long position in WTI-linked futures and options contracts equivalent to almost 413 million barrels of crude oil, according to the U.S. Commodity Futures Trading Commission (CFTC).

WTI prices had risen to $106 per barrel, and Brent was at $113, and yet most hedge funds had positioned themselves to benefit from further price increases.

Hedge funds' long positions (451 million barrels) outnumbered their short positions (38 million barrels) by a ratio of almost 12 to one.

Just three weeks earlier, the imbalance had been even more pronounced, with a long-short ratio of almost 15 to one, the biggest since the series began in 2006 (http://link.reuters.com/pew43w).

But prices started to fall, rather than rise, and most hedge funds found themselves sitting on positions that were losing money (or giving back earlier profits).

Thus began a race to offload losing futures and options positions and try to square up or get short, which only accelerated the decline in prices.

Between mid-June and mid-November, the number of hedge funds with significant long positions above the CFTC's reporting threshold fell from 117 to just 72.

Over the same period, the number of funds with reportable short positions almost doubled from 36 to 69.

The ratio of long-to-short positions fell from 12 to one to less than three to one.

Hedge funds' net long position more than halved from 413 million barrels to just 168 million on Nov. 4, a turnaround representing an enormous 244 million barrels in just 20 weeks.

Throughout the last five years, there has been a close correspondence between WTI oil prices and the number of hedge funds with reportable long positions in NYMEX WTI futures and options contracts. (http://link.reuters.com/rew43w)

This is not the time or the place to discuss whether changes in hedge fund positioning drive changes in oil prices or the other way around, whether hedge funds initiate price changes or merely follow trends.

Given the close correspondence between hedge fund positioning and WTI prices over the last five years, however, it comes as no surprise that the brutal slide in oil prices over the last five months has been accompanied by an equally huge turnaround in fund positioning.

In a world of limited liquidity, such a turnaround was bound to accelerate and magnify the price drop, contributing to the negative or inverted bubble exhibited since June.

The question is whether the turnaround in positions has now run its course.

The number of hedge funds with reportable short positions is now close to its highest level at any point since 2006, while the number of funds with reportable longs has fallen to the lowest level since the recession in 2008-2009.

There is no way to call the top (or bottom) of a bubble, but the hedge fund data indicates that the adjustment in speculative positioning may be nearly done.

By John Kemp