OTTAWA — Hedge funds and institutional investors, who were widely blamed for accelerating crude oil's price rise over the past three years, now appear to be bailing out, adding to producers' concerns over warm weather and a slowing North American economy.
Crude oil prices were whipsawed on the New York Mercantile Exchange Tuesday, losing $2.20 (U.S.) a barrel to an 18-month low of $53.88 in early trading, before recovering to close at $55.64.
The price for the benchmark West Texas intermediate has dropped 9 per cent in the early days of 2007, and analysts say the money managers who had piled into energy commodities over the past three years are now looking to get out.
Motorists are seeing the benefit of that crude oil decline, as pump prices fell in most markets across the country last week, according a weekly survey by independent analyst MJ Ervin & Associates Inc.
In its weekly survey released Tuesday, the company said the national average pump price for regular unleaded gasoline fell to 88.9 cents (Canadian) a litre, down 2.9 cents.
The national average hit $1.10 a litre last summer, and has been hovering above 90 cents for the last several months.
Analysts blame the unseasonably warm weather in northeastern United States and Europe for the weakness in crude prices, but the decline has been exacerbated by the sheer volume of hedge fund and pension fund money that was invested in energy futures in recent years.
Doug Leggate, an analyst with Citigroup Global Markets Inc., said the influx of investment money into the commodity market in the past three years added some $35 (U.S.) to the price of crude oil, when it peaked at $78.20 a barrel last summer.
But what the funds drove up, they are now forcing lower, by getting out of energy-based indices and short selling energy futures. (In short selling, a trader essentially makes a bet that a given security will decline in price.)
“Weather is not the major factor here,” Mr. Leggate said in a report Tuesday. Rather, he said, “the severity of this move points to funds exiting.”
Mr. Leggate said the intraday decline below $55 a barrel breached a key resistance level, setting the stage for even lower prices in the coming days. However, other analysts said the market appeared to set a new floor when it rebounded after traders had concluded the market had sold off too quickly.
John Kilduff, senior vice-president of energy risk management with Fimat USA, said financial investors now dominate the energy futures markets, and had set their sights on $55 as a trigger point for a selloff.
“With all the speculative money in the market, watching the technicals as they do, it kind of just fed on itself,” Mr. Kilduff said of the sharp decline. But the market then rebounded just as quickly, when commercial buyers took advantage of 18-month lows and locked in relatively low-cost supply.
As a result, Mr. Kilduff said the $55-barrier has been reinforced as a floor. “We really needed the market to close below $55 to have this turn into a real rout, or lasting rout to the downside. Now, the support is even stronger than it was coming into today, at least at the intraday low.”
Fadel Gheit, analyst with Oppenheimer & Co., said money managers' investment in energy commodities has grown tenfold over the past few years, and their presence has made for far greater volatility, and for more extreme price movements.
“There was no reason for oil prices to open the day down almost $2.50, and then all of a sudden, they recover,” Mr. Gheit said. “It's typically a manipulated market, manipulated by the large financial institutions.”
The analyst said the funds are also distorting prices in natural gas, home heating oil and gasoline markets. “They are basically manipulating the market and exaggerating it beyond sustainability.”
Raw materials slump could mean heartache for commodity funds
Unseasonably warm winters pummel energy prices
The same financial investors who have pumped tens of billions of dollars into index-linked commodities funds, helping to drive prices skyward in the past five years, could also turn the current slide in raw materials into a rout, National Bank Financial Inc. contends -- and the tipping point may not be far away.
"I'm not sure that investors . . . would put up with, let's say, three consecutive quarters of negative returns without paring some of their positions," Stéfane Marion, the firm's assistant chief economist, said yesterday, as key commodities such as oil, copper and tin took another pounding in the market.
"When you've been dealing with five consecutive years of inflows into such funds, if the inflow just stops, you're losing some support for demand," he said when reached in Montreal. "And if there are outflows, that's something else."
The Goldman Sachs Commodity Index, the benchmark for many of the commodity funds that have sprung up around the world, is down 15 per cent from a year ago, largely because of its heavy weighting (about 70 per cent) in energy, where prices have been pummelled by unseasonably warm winters in North America.
This decline has previously been exceeded only during the Asian Crisis of 1998 and the 2001 U.S. recession, Mr. Marion said.
The index, which hit a record high of 7,634 points in September 2005, has tumbled in each of the past two quarters, meaning the day of reckoning Mr. Marion figures may be at hand, could come at the end of March if it continues to plunge. In midafternoon yesterday it had fallen to 5,268, down 150 points. Research by Goldman Sachs shows that investment in commodity index funds -- which invest through the futures market rather than in physical commodities -- had risen to about $90-billion (U.S.) by the end of last year, up tenfold in six years. Mr. Marion told clients in a note earlier this week that "in our opinion, this huge sum of money makes financial demand one of the largest potential sources of volatility for commodity prices."
This figure excludes billions more pumped in by other investors.
Citigroup Inc. estimated last April that in all, about $200-billion was then invested in the sector, about 30 per cent of it by the index funds, 30 per cent by hedge funds and the remaining 20 per cent by so-called commodity trading advisers, who also trade other sorts of assets.
With supply and end-user demand "relatively tight" in most commodity markets, "marginal demand" -- or the lack thereof -- from the index funds on their own has come to have a significant impact on prices, in Mr. Marion's view.
"So if, at the margin, financial demand dries out because investors are taking profits or have a sense that commodity prices might be capped for a while in [an economic] slowdown, then it will, I think, exacerbate the downside," he said.
The danger is that a continued U.S. slowdown could cut demand for manufactured goods and, in turn, for many commodities.
Some analysts do not buy Mr. Marion's argument.
"The money that's come into [these] funds I do not believe is going to be seriously affected by pullbacks and selloffs . . . like the one we've had today," Adam Rowley, a London-based metals analyst for Australia's Macquarie Bank Ltd., said when reached yesterday.
He figures mutual funds and other investors who have bought into the index-linked funds generally have put only about 2 or 3 per cent of their total portfolio there, and that they have done so to try to improve overall returns.
In fact, he and several other Macquarie analysts said in a note to clients that there is a "common misconception" that investors in these funds "demand" a positive return. "They want a positive return for their overall fund, not necessarily the commodities component alone. Last year some commodity funds were down 10 per cent to 15 per cent, but many equity markets were up 20-per-cent-plus, so the mutual funds are happy."
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