INSURANCE HEDGE ON OIL INDUSTRY
Why Hedge Funds Shouldn't Be Bullish on Oil
Hedge funds are bullish on oil right now. Should they be? Hedge funds have gone long on oil for several reasons, including the potential for a supply cut, increased demand for gasoline and the potential for global economic expansion.
Oil Price Logic
Since oil has been rallying, it might seem risky to call out hedge funds because of their bullish bets, but please allow me to clarify. Hedge funds might be correct by increasing their bullish bets on oil, but only for a limited amount of time. Logic always wins in the end, and sustainably higher oil prices is illogical and does not work. (For more, see: The Changing Economics of the Oil Business.)
First off all, the biggest catalyst for the rally in oil has been short covering. Do you know what happens when people begin to cover their shorts on Wall Street? Other shorts get nervous and cover their shorts as well. Then you see snowball like momentum. These rallies often overshoot to the upside, where prices are much higher than where they should be on a fundamental basis.
According to Dennis Gartman, the editor and publisher of The Gartman Letter and alsoknown as The Commodity King, wells that have been capped could be brought online quickly. If supply is already abundant, then you have a bearish situation brewing. (For more, see:Gartman: Oil Swings to Flatten Out at $27-$47.)
There is weaker than expected oil demand. There are several reasons for this. The most important is slowing global economic growth, which Federal Reserve Chair Janet Yellen has admitted to and the International Monetary Fund (IMF) has warned about. To watch investors and markets ignore this trend is mind boggling. If populations are declining in the U.S., China, Japan and Europe, this means fewer consumers. Therefore, the global economy can't possibly grow on a sustainable basis. This is why oil demand is low. It’s not rocket science.
Gartman made another excellent point. He pointed out that since Uber’s inception, U.S. miles traveled has declined. Many Millennials see no need to own a car thanks in part to Uber, which keeps their costs down. Millennials love to keep costs down. This trend won’t be noticeable just yet, but it is a long-term threat to oil prices. It’s also a long-term threat to auto manufacturers. If you don’t think Uber is a threat, it now operates in 400 cities and has provided more than one billion rides. These numbers will only move higher. (For more, see: 5 Investors Who Move the Market.)
Gartman sees $47 a barrel as the maximum price for industry profitability. If you see $47 a barrel, you might want to get aggressive on the short side. However, that’s your call.
Another reason for the rally in oil is the potential for a supply-cut deal, but Iran won’t allow this to happen. Even if there is a deal, it's not going to change the demand situation. Then you have to factor in the long-term alternative energy threat. Oil will not perform in the 21stCentury like it did in the 20th Century. (For more, see: Oil Posts 5th Consecutive Weekly Gain.)
The Bottom Line
The recent rally in oil was driven by investors, not fundamentals. The risks to oil prices now include abundant supply, weak demand, Uber, alternative energy and investor profit taking. Oil might spike in the near future, but its days as king are nearing their end. Therefore, unless they're short-term trades, most hedge funds are likely wrong with their bullish oil bets. (For more, see: Top 5 Oil and Gas Bond ETFs for 2016.)
SOURCE : INVESTOPEDIA
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