HardAssetsInvestor

Written by Julian Murdoch  |

September 16, 2008

The Baltic Bet

Details

The shipping index has been decimated in the last few months, and there's a new ETF on the street. Is it time to buy?

• The Chinese demand bet
• Oversupply through 2015?
• Required reading

 

The last time we looked at shipping was all the way back in April. At the time, we commented on the new entrants into the index market for dry bulk shipping - UBS and their Blue Sea Index. Six months later, we have another new entrant; this time in the form of an actual, investible exchange-traded fund.

A quick refresher: Shipping rates are tracked primarily by the Baltic Dry Index, a blending of the rates to ship dry goods (largely ores) on three different-sized boats on the four main shipping routes. Back then, we safely commented that nobody was actually doing much in the way of derivatives on the BDI beyond freight forward agreements. In other words, for most investors, it was functionally untradable.

It turns out not having some kind of derivatives=based Baltic Dry ETF was a blessing in disguise. Since a heady peak in early summer, the BDI has lost an astonishing 50% of its value.

 

 

 

Looked at in the long term, the recent decimation in shipping rates has essentially obviated the entire commodities boom, resetting the shipping market back to 2006 levels.

 

 

 

So what the heck happened? China. Going into the Olympic games, China stopped buying pretty much anything. So far, China doesn't look like it's started buying again, but it's just a matter of time. But the restart won't be instant; Lloyd's List is reporting that there are 70m tones of iron ore just sitting in Chinese ports still waiting to be unloaded. It will take some time - my guess is a quarter or two - for the shipping market to stabilize back into any kind of run-rate demand.

All this volatility has understandably increased interest in locking in prices through derivatives, and indeed, freight forward agreements - the main way shippers lock in prices - have been steadily increasing in volume. In May, ICAP - a British derivatives firm, bought JE Hyde, a ship broker, and in June launched full electronic trading of OTC shipping. Also in June, IMAREX launched a full-on BDI futures contract. While not as accessible as one of the established U.S. exchanges, it's a real and booming market, with BDI futures trading a nominal $1 billion in August, a 50% increase in size over July. This month's issue of The Baltic - 100% required reading for commodities investors - predicts that overall derivatives activity in shipping will increase 25% in 2008.

For most investors, the only way to play the shipping game has been through the shipping companies - the equivalent of a pick-and-shovel miner approach in gold: companies like DryShips (DRYS) and Diana Shipping (DSX). As you'd expect, these stocks have been slammed alongside the revenues predicted by the BDI. After all, they're the sellers of the commodity represented by the BDI - the use of ships.

 

 

 

I will admit, there's a part of me that looks at a chart like this and screams "buy buy buy" with Jim Cramer-like enthusiasm, minus the mania and forehead sweat. After all, the fundamentals should stay strong, if emerging markets and China still plan on pressing forward into the 21^st century.