Oil’s Record Bearishness Shows Market Increasingly Run by Algos

(Bloomberg) -- For the last few weeks, speculators have been wagering against oil prices like never before. 

That’s partly because of forecasts that rising production outside of the OPEC+ alliance will create an oversupply of crude next year. Concerns about a weakening global industrial complex also are dogging the market, as shown by significant bets against diesel prices. 

But the sheer size of the positions — oil recently had more bearish bets than when OPEC started a price war at the onset of the Covid pandemic — points to a deeper market shift. Investors who hold oil to protect against inflation have nearly vanished, and next year’s bearish price outlook is scaring discretionary traders from buying crude’s dips. Their retreat has let commodity trading advisers — trend-following funds that trade largely on technical indicators — gain even greater prominence and build up huge short bets. 

“Net-short positions in oil are a big deal,” said Ilia Bouchouev, a managing partner at Pentathlon Investments who also teaches at New York University. “Several groups of market participants are now operating with the lowest sentiment.”

With central banks shifting their focus from taming inflation to cutting rates to protect the economy, fund managers have slashed their allocations to commodities to the lowest in seven years, a Bank of America Corp. survey for September showed. 

That exodus has helped leave positions of money managers such as hedge funds hovering at the most bearish levels in data going back to 2011 across a combination of all major oil contracts. This month, those investors turned net bearish on Brent crude for the first time ever and continue to hold record net-bearish bets on diesel futures and options. 

With CTAs increasingly in the drivers seat, there have been at least three instances in the past two months alone where these algorithm-driven traders were credited with having exacerbated moves in both directions, leading to prices whipsawing.

“It’s terrible. No one has conviction,” said Trevor Woods, chief investment officer of Northern Trace Capital, which largely employs discretionary trading strategies.

The fundamental picture for crude accounts for much of the bearishness. Globally, inventories are expected to increase, with supplies in storage in OECD countries swelling to about 2.73 billion barrels in 2025, according to an estimate from the US government. 

Demand from the fuelmaking sector also is showing cracks as refineries in Europe curb processing rates and as profits from making fuels such as gasoline and diesel in the US plunge to near the lowest levels since the pandemic, seasonally. 

Still, the extreme positioning raises the risk of a sharp unwind, and the market isn’t without potential bullish catalysts, such as recent supply disruptions in Libya, stimulus measures from China and aggressive rate cuts from the Federal Reserve. At the same time, US crude inventories fell to the lowest since April 2022 last week. 

“We remain structurally bearish, but there is discomfort that bearish views are now unanimous,” Macquarie analysts wrote in a note.

Some discretionary traders also are wary of taking significant positions ahead of the US election, which could have a wide range of effects on the oil market, several traders said. That uncertainty, during what has already been a tricky year for many traders, is further discouraging them from buying oil anytime soon. 

“It’s like a ghost town,” Northern Trace’s Woods said.  

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