Investors tend to assume that when the price of oil tanks, as it did Tuesday with its $4 decline, than there must be something wrong with the fundamentals. Some may conclude that oil must be the latest victim of the slowing global economy, or that OPEC is suddenly willing to let the price drop is in order to stop the North American oil boom.
But what if that is not the reason? What if it the oil market is just like the stock market, and the buyers and sellers are actually controlling the market?
Jim Cramer doesn't think this is a ridiculous idea. He suspects that the real force that is controlling the price of crude is the buyers and sellers themselves, as a result of forced liquidations and margin calls among overly bullish hedge funds.
That might sound overly cynical, but Cramer thinks it's worth examining. To gain further clarification, the "Mad Money" host turned to Carley Garner, technician and co-founder of DeCarley Trading to explain how this could really happen.
Back in the end of May, Garner predicted that the market would see a hideous decline in oil, precisely because the bullish hedge funds bit off more than they could chew. She called the decline, and Cramer thinks she could even call the bottom, too.
According to Garner's research—based on a chart of the West Texas crude that shows CFTC's commitments of the big institutional players—in June, speculators were holding net long positions in crude futures. When the price in oil began to fall, the speculators in the market began to suffer losses as a result. However the hedge funds selling crude did not sell, and are now being forced to sell because they bought these future contracts on margin. Now that the value of these contracts has dropped, the margin clerks at investment banks are requiring them to put up more capital or sell their positions.