Wild swings in oil prices will continue for months to come, after volatility hit a two-year high this week, as trading is increasingly dominated by relative newcomers to the market.

Oil and other commodities markets have gone on a rollercoaster ride since May 5, reacting wildly to economic, currency and inventory data.

“It will persist until the end of the year, and there will be more violent swings in both directions,” said Angelos Damaskos, chief executive officer of Sector Investment Managers, which manages the Junior Oils Trust and the Junior Gold Trust. “It will be the fourth quarter before we see more stability.”

Close-to-close volatility for the world’s two crude oil benchmarks, North Sea Brent and U.S. light crude, known as West Texas Intermediate or WTI, has rocketed to well over 60% after two years of declining price moves.

Fund managers and analysts say the heightened volatility reflects increased levels of retail investment and speculation in the commodities markets as exchange-traded products provide easy access for investors with little experience.

“We are seeing a lot of less skilled commodity investors who come in and will hop on a trend,” said a UK-based commodity hedge fund manager who asked not to be named.

“When there is a small news event that triggers a correction, either they’ll misinterpret it or the trend will temporarily change, there will be a bit of a dip, and they will quickly sell out on that.”

“ON THE SIDELINES”

Michael Korn, president of Princeton, New Jersey-based over-the-counter broking house Skokie Energy, said volatility was being encouraged by very large sums of money being deployed by fund managers and non-professional investors.

“The funds being wielded have been growing,” Korn said. “It seems like every two to three months we have a new record in speculative open length.”

Carl Larry, director of derivatives trading and research at Blue Ocean Brokerage, said there were huge sums of money moving around very quickly, some being invested by people with little experience, and that this was prompting physical traders to sit out during very rapid price moves.

“Physical traders are definitely on the sidelines until the volatility stops,” Larry said.

“We’re losing any participation from commercial traders trying to get caught in these over-extended moves. When you take that stop gap out of the market, all you are left with is a bunch of funds dictating direction,” he said.

Increased futures volatility is also keeping traditional players such as physical traders on the sidelines, making it difficult for them to hedge their supply and demand requirements.

Last week investor sentiment changed due to doubts about global growth as China raised interest rates. That followed several months of worries over the loss of oil supply from the Middle East and North Africa as civil war in Libya shut down exports.

Crude oil fell more than US$20 per barrel last week, with North Sea Brent tumbling to a low of almost US$105 before a partial recovery, but prices have continued slide this week with total daily price moves of up to 8.5%.

SYSTEMATIC TRADING

Higher margin requirements for oil and silver on the CME

futures exchange have also forced speculators to adjust their positions, adding to choppiness.

Fund managers also pointed the finger at systematic trading, which triggers stop-losses when technical levels are breached.

Nigol Koulajian, chief investment officer of commodity trading adviser Quest Partners, said market reversals are getting faster in oil and grains, a by-product of too many people trading the same type of strategy.

“When the market is going up, you get a positive feedback loop, so the price gets reinforced as people add to their positions. But when the market corrects, everyone is running out the door at the same time,” he said.

Koulajian said this was much stronger than it used to be as there are more people trading on the technicals.

Investors see no reason why the extraordinary volatility should not continue as worries about the end of quantitative easing, the euro zone debt crisis and inflation combine.

Koulajian said quantitative easing had encouraged investors to buy commodities in order to preserve their savings.

“The liquidity in commodity markets is minute compared to financial markets,” said Koulajian. Even a small shift in assets from financial to commodity markets will therefore result in substantial swings in commodity prices, he said.

“We are only in the beginning stages of this shift and we expect much more volatility and price increases ahead.”

Article provided via the Financial Post

http://business.financialpost.com/2011/05/13/why-oils-wild-ride-is-far-from-over/