Oil Price Fundamental Daily Forecast – Hedge Fund Selling Could Fuel Correction

U.S. West Texas Intermediate and international-bench mark Brent crude oil posted potentially bearish closing price reversal tops on Tuesday. Although not a trend-changing event, the chart pattern could fuel the start of a 2 to 3 correction, or a 50% retracement of the recent range.

At 0734 GMT, March WTI crude oil futures are trading $63.72, up $0.05 or +0.08% and April Brent crude oil is trading $68.81, up $0.03 or +0.04%.

The selling started on Tuesday when an analyst at Swiss bank said a price “correction should occur … (as) hedge fund expectations for further rising prices have reached excessive levels.”

 Forecast

Over the long-run, crude oil is likely to be supported by the OPEC-led production cuts and strong global demand. The tightening supply/demand situation has helped fuel a 13 percent gain in crude oil prices since the markets bottomed in early December. Also contributing to the rally has been a surge in hedge fund buying.

We’ve been saying lately that we’ve been suspect about the rally because it has been primarily driven by hedge fund buying. We know from the past that they have often tipped the scale to overbought. We also said that at some point in the rally, the hedge fund buying will stop because of concerns over valuation.

The comments from Swiss bank share a similar view. The main concern about hedge funds is that they follow the herd. So if one starts to sell off its profitable positions, they all start to sell and this tends to lead to a violent correction.

Due to the size and duration of the current rally, we can build a case for a correction by WTI crude oil into the 50% level at $60.41 and the Brent contract into $65.52. How fast the markets get to these levels will be determined by how aggressive the hedge fund selling is.

We know that over the long-run, crude oil prices are likely to continue to be underpinned by the solid economy with strong oil demand tightening global oil inventories, however, we do feel that prices are ahead of the fundamentals and likely due for a short-term correction.