Lessons From "God"
Monday, August 21, 2017
It’s not every day one learns about the demise of “God”. No, we’re not referring to a religious deity; we’re talking about Andy Hall, an oil trader recognized for his ability to successfully predict the direction of oil prices. While his career spans four decades, many people had never heard of Mr. Hall until the global financial crisis when Citigroup Inc. disclosed that he made $100 million trading oil in 2008. Given his trading success and background, Mr. Hall was nicknamed “God” of the oil markets.
In August of this year, Mr. Hall announced that he was closing down his flagship hedge fund, Astenbeck Master Commodities Fund II, after reportedly losing almost 30% during the first half of 2017. Mr. Hall was expecting a sustained rally in oil prices due to production cuts from the Organization of the Petroleum Exporting Countries (OPEC); sadly, that hasn’t happened yet. But the magnitude of the decline in Hall’s fund cannot be simply explained by a drop in oil prices given that the Brent oil price benchmark declined only 16% during the same time period. According to Bloomberg News, Astenbeck’s poor performance in 2017 may have been due to holding concentrated positions in relatively small markets and excessive leverage.
In an August 1st letter to investors, Mr. Hall attributed the closure of his hedge fund to a weakening oil outlook for 2018 and the dominance of algorithmic trading systems, which made it harder to trade oil based on the fundamentals of supply and demand. Interestingly, Mr. Hall also acknowledged that his decision to shift from a long-term oil bull to an oil bear could be viewed by some as a contrarian signal.
Regarding the long-term price of oil, Mr. Hall suggested that there is currently no consensus due to the rise of U.S. shale production. He stated that oil price bulls believe the U.S. shale oil business model is unsustainable at current prices, while bears believe technology will continue to drive down costs and increase recoverable reserves.
We are bullish on the long-term price of oil, which we believe will be determined by supply and demand fundamentals in the long run, rather than algorithmic trading systems. We expect modest growth in global demand for oil to eventually reduce the excess supply in the market today and lead to higher prices. While recognizing the potential for further technology improvements in U.S. shale oil production, we believe the marginal cost of production will eventually increase as industry activity intensifies. We believe oil stocks are attractively priced because there is a lack of consensus on the direction of long-term oil prices. In other words, oil company stocks are not discounting an expectation that oil prices will rise significantly.
Notwithstanding our bullish view on long-term oil prices, the closure of Mr. Hall’s hedge fund is a good reminder of the dangers of excessive leverage and overly concentrated investment positions. Given the volatile nature of commodity prices, we believe that investors should hold well-diversified portfolios with limited commodity resource exposure. Investors also need to be patient when it comes to investing in commodity resource stocks as even “God” can’t predict what happens in the short term.