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Hedge fund manager bets on continued crude slump

Date: Monday, December 8, 2008
Author: Martin de Sa\'Pinto, Guardian.co.uk

Crude oil prices could fall as low as $20 a barrel in 2009 as falling U.S. demand outstrips Chinese growth, asset manager Jacques Mechelany told Reuters this week.
Having already profited handsomely from the steep decline in crude prices, Mechelany intends to continue to take short positions in crude oil futures and selected oil-related stocks.
The forecast may seem excessively bearish, but Mechelany is used to sticking his neck out. His $50 target for 2008 must have seemed equally ambitious in early July 2008, when oil prices were peaking at almost three times that level.
"Prices tend to overshoot both on the upside and on the downside. In the context of the latest movement $20 is only one standard deviation from $35, which I consider to be the long-term equilibrium price," said Mechelany.
He based his estimate of the long-term fair value of crude on long-term supply and demand trends. However, he said, prices may fall below fair value for a period.
"When oil prices begin falling leveraged investors have to unwind positions, further depressing prices," he said.
Mechelany's company was previously known as Heritage Fund Management (HFM), a joint venture founded in 2006 between Mechelany and Geneva-based private bank Heritage Bank.
Bank of China bought 30 percent of HFM in July, raising its stake to 70 percent on Nov. 20 after receiving approval from the Swiss Federal Banking Commission.
Mechelany holds the remaining 30 percent of the entity, which has been re-branded Bank of China (Suisse).
Crude oil was trading at $70 and the asset management company was still known under its old moniker in mid-2007 when Mechelany began taking short exposure to crude.
It continued to rise to a maximum of $147.27 on Jul. 8, 2008, provoking losses to the short futures positions held by Mechelany's funds.
However, the funds continued to maintain short exposure to oil, and have reaped rewards since July, although Mechelany would not say exactly how much his company has earned on the trades.
He uses a number of macro-economic factors to back up his oil price thesis.
For instance, oil consumption in the United States, the world's biggest consumer, has fallen 8 percent from its peak, he said, and China would not take up the slack any time soon.
"Chinese oil consumption is much lower than in the U.S., and has never grown at more than 8 percent per annum. To the middle of this year some firms vastly exaggerated China's consumption growth, feeding speculation on oil prices," he said.
Mechelany maintained the commodities bubble that burst earlier this year was an accident waiting to happen, and that it was fuelled by upbeat research reports and overactive trading desks.
"The whole speculation in commodities has been driven by a few houses who have been trading their books at the same time," said Mechelany.
"Some of them have made vast profits while the clients they were advising have racked up losses. You'd need to look at their books to see whether their trades were consistent with their research reports," he said.
Not everything has gone Mechelany's way this year. Although his oil bets and a strong conviction trade on a rising dollar have boosted his fund returns, he has also taken some hits.
The 788 China and 788 Japan funds, sub-advised by Mechelany's company, have lost heavily this year after taking leveraged exposure to equities. Both funds were among the best-performing hedge funds in their categories in 2007.
So far, 2008 has been a different story. Some clients said the China fund was down as much as 95 percent at end-October, while the 788 funds website says the Japan fund lost 66.6 percent in October alone.
"We expected that once China and Japan had fallen 40 percent from their peak, valuations would be in tune with the fundamentals. The tsunami of deleveraging has effectively prevented this," Mechelany told Reuters. (Editing by Andrew Macdonald)