U.S. hedge funds are rapidly unwinding "long and wrong" speculative positions on crude oil prices, exacerbating the sell-off in the commodity price.
On July 11, I noted that hedge fund speculation on oil prices had reached extreme bullish levels and that a "rush to the exits would cause considerable volatility in energy prices." Unfortunately, it looks like that's what we got.
In hindsight, it's clear that the speculative frenzy in North American oil prices had already peaked at the end of June. The Non-Commercial (ie, hedge fund) Net Long Futures Position on West Texas Intermediate crude – the number of futures contracts betting on higher oil prices minus the number expecting lower prices – has declined 25 per cent or 94,240 contracts since.
The crude price itself has fallen $5.06 to $97.64, however, which is unsettling but hardly a massacre.
The chart below updates a comparison between the crude price and speculative futures positions. As always with charts with two y-axes, there's a limit to how much we can read into the relative paths of the two trends just by looking. That said, it appears the majority of the speculative froth has been removed from crude futures markets.
SOURCE: Scott Barlow/Bloomberg
This by no means guarantees that crude prices have stabilized. The futures market is only one factor affecting day-to-day fluctuations in the commodity. Recent strength in the U.S. dollar, for example, was also a factor in pushing oil prices lower.
Speculative excess in futures markets or, more specifically, the risk that it would unwind and put downward pressure on energy prices, was a risk looming over commodity prices that has seemingly been addressed. Investors can expect oil price volatility to decline as a result.
Follow Scott Barlow on Twitter @SBarlow_ROB.