Mad Money

Cramer on oil: Hedge funds gone wild?

Vincent Kessler | Reuters

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.

Garner indicated that the price of oil may continue to go down until these forced liquidations are completed.

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Here is the good news: Cramer thinks that as soon as the weak handed bulls have finished selling, the markets will reverse when they are flushed out.

Where does Garner see the bottom of oil? On Tuesday the price of oil broke below its key support level at $83, which Garner believes it could be headed down to its next basement level of support, $77. In August 2011 this was the point in which the market found a reason to rally, and she thinks it could happen again.

"In short, worse case, Garner sees oil bottoming in the high $70s, and at that point, she expects a big rebound, because crude is already in incredibly oversold territory that almost demands a bounce," Cramer said.

He thinks that perhaps this hideous drop in oil could really just be a case of hedge funds gone wild with weak hands. If Garner is correct then he thinks that once the forced liquidations end, then there could be brighter days ahead for oil bouncing back.

Call Cramer: 1-800-743-CNBC

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