Weakening Signals Test Oil Bulls' Confidence

Copyright © 2021 Energy Intelligence Group

The paper oil market has been driven for a good portion of this year by a combination of bullish "carry" and "momentum" signals, but those signals have weakened recently, providing less support to prices. "Reflation" trades -- based on expectations of economic recovery -- have come under more scrutiny, and oil market fundamentals are back in the spotlight (IOD Aug.6'21). Carry trades are based on an assessment of oil inventories, while momentum trading tracks technical signals that measure the rate of change in prices. Some traders seek to make profits by combining the two types of signal. They use so-called "carry-momentum" strategies to track early signals about likely changes in inventories that are usually linked to variations in prices. Weaker Signals In recent weeks, longer-term momentum indicators have been weakening and as that has happened prices have been less able to resume their uptrend after each sell-off. This explains the recent "dead-cat bounces" in which prices failed to consolidate after an initial rebound. Accordingly, market bulls have sold off about 15% of their previous length over the past month or so. "For oil to regain its strength, the bull must be constantly fed. The range-bound market we have seen for two months is automatically bearish," said Ilia Bouchouev, managing partner at Pentathlon Investments. One reason for the market's more bearish tone is that inventories are not particularly low for this time of the year. To send a bullish signal, inventories of crude oil and refined products need to fall to about 57 days of forward demand cover or lower. But Energy Intelligence estimates that global stockpiles are still five days -- or about 200 million barrels -- above that threshold. Reflation Questioned Many traders still have confidence in the reflation trade, which is evident from the large number of bullish bets that remain open -- the equivalent of about 566 million bbl of oil, according to exchange data. But even if there are few signs so far that such trades are being unwound, "there is a lot of evidence that the reflation trade is being rethought," CME Group Chief Economist Bulford Putnam told Energy Intelligence. "The biggest evidence is in the interest rate markets," Putnam said, noting the recent decline in the yield on 10-year US Treasury bonds. Concerns about the Delta variant of Covid-19 and the slow pace of vaccination in Asia and Latin America have given investors pause as they try to figure out what lies ahead for the global economy. Living With the Virus "The rebound period, which I'll count from, say, September 2020 through June 2021, is basically over, and we're now trying to figure out how we live with this virus knowing that we won't get to herd immunity," said Putnam. The oil market's focus has shifted back to fundamentals, with recurrent sell-offs cooling appetites for speculative activity. Not so long ago, the market valued Brent crude at well above $70 per barrel, with some arguing that $80/bbl was within reach That seems less likely now, although ongoing inventory draws through the rest of this year should provide some support to Brent. Julien Mathonniere, London

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