‘Tis a Perfect Storm Coming, Me Hearties. Michael Wilson Checks Out the Dodgy Macro-Economic Omens From Bulk Carrier Rates
I can tell you whether it’s going to be a long hot summer. Honestly I can. All I have to do is look up into the trees where the rooks and crows are nesting, and if the nests are in the very topmost branches I know it’s time to get the sun-loungers out. A few feet further down into the tree, and maybe that fortnight in southern Spain would be a better idea? The crows just know this stuff instinctively.
Nobody knows for sure whether this piece of old English folklore has any factual basis, but the fact that it’s survived this long says something about the human brain’s willingness to believe in it anyway. We’ve known for centuries that our minds are constantly looking for clues as to which way the world is going. And we darkly suspect that some predictors are more reliable than others. Although exactly why they should work is often a matter of some uncertainty.
A Good Idea, In Theory
So, to my point. (Finally.) Somewhere just north of the Fibonacci numbers in the futurologist’s toolkit is something that they call the Baltic Dry Index (BDI). It’s a set of numbers that are issued every morning by a panel at the Baltic Exchange in London, and essentially, it’s a weighted average of the prices that the world’s shipping fleets are charging for international bulk cargo, especially raw materials. According to some, it’s a sensitive and reliable indicator of the mood in world trade. Which in turn is bound to give us a pretty good hint as to the direction of the world economy. Isn’t it?
Well, you can at least see the logic there. When there are ships sitting idly in port, or when they return from a delivery run with nothing in their holds, that’s not just bad for their owners, it’s also a sign that something is terribly wrong somewhere. Shipping is a ferociously competitive business at the best of times, so the last thing a ship owner ever wants to do is go anywhere unladen. Like an unsold airline seat, an empty cargo hold is a missed opportunity that means it’s sometimes cheaper to do the job for a tenth of your normal fee than not to make any money at all.
Except, I suppose, that, unlike a scheduled airliner, the captain does have the option of staying put and doing nothing until business improves. Of course, that won’t make the company’s accountants happy because it still costs a fortune to keep an expensive, rapidly depreciating vessel in harbour. But you get my point. The pressure always going to be on the shipping company to pitch its bids as low as necessary to get the business. Sometimes, as we’ll see, that might be very low indeed.
A Storm-Tossed Sea
But the volatility that results can be downright shocking. It isn’t just a macro-economic matter of whether or not China has decided to hold back on steel imports until August, or whether Russia is driving up the price of gas and making us Europeans worry about getting in enough supplies of LPG for next winter. It isn’t even the question of shrinking consumer demand, deflation and all the rest of it, as the apologists would have you believe.
No, it also comes down to the geographical distribution of those ships, their age and type – and, of course, the number of boats that are actually available for hire. (A number which has been declining in recent decades, by the way. Even the Koreans aren’t getting any shipbuilding orders this year.) And on the willingness of assorted banks to write the credit notes required for any transhipment.
And so on, and so on…..
So What’s All This Got to Do with Investors?
A good question. You can’t buy the Baltic Shipping Index, because it doesn’t have any assets. It’s just a number, remember. But if you’re that way inclined you can certainly buy a derivative or synthetic product that will reflect the outturn of this highly mobile index. The question is, would you really want to?
For many investors, the answer is yes. People with large positions in commodity providers may wish to use the Baltic Dry, or some inverse variant of it, as a hedge against any future catastrophic downturn in global shipping demand. But a fair number of individuals – including some hedge fund managers, alas – have seen it as an instrument for what amounts to out-and-out gambling. It makes spread betting look positively tame.
For Those in Peril On the Sea
The following chart ought to make the point. What it shows is that the supposed long-term BDI average of around 1,000 is anything but stable. Between 2002 and 2008 the index soared by a ridiculous 1,000% to nearly 11,000 – only to drop back by nearly 50%, and then to re-take the heights with an all-time record of 11,793 in May 2008
After which, the only way was down. 94% down, in fact, to just 663 points in December 2008 – the lowest since 1986. And at those rates, no bulk shipping company in the world was making any money at all. Yes, it quickly quadrupled to a shade over 4,000, but that didn’t last either. By the start of last year it was down around 700 (ouch), then up to 2,340 last December, only to collapse back to 1,000 at the start of May 2014.
(Click to View Full Screen)
(Source: Wikimedia Commons)
What, as Adrian Mole would have asked, can it all mean? None of this corresponds to the real-world state of the global economy in any obvious way. The downturn in Chinese trade has been marked, to be sure, and the 30% slump in raw materials has certainly been a factor. But there’s nothing there that really ought to justify these gargantuan leaps. Is there?
We can probably argue about that until the cows come home, and even then we’ll still be trying to figure it out in the pub afterwards. Some say that it’s down to the uncertainty over Ukraine, and others that China’s new focus on its domestic market threatens to screen out a lot of foreign business. Some even blame America’s own ‘onshoring’ of manufacturing tasks that used to be done cheaply in the Far East.
Blame The Banks?
But my money is on the reluctance of cash-strapped banks to lend on shipping projects. Over the last few years, the traditional source of finance for shipping companies has been going deaf to the industry’s pleas for new investment. So that’s 70% of the financing market that’s really not very certain any more. And, according to industry estimates, the global shipping industry is having to turn instead to private equity.
That’s an expensive option, and it also takes a while to get it under way. The companies are said to have raised around $30 billion in private equity so far, but there’s still a $70 billion shortfall on what they’d really like to have. There’s a big move going on toward stepping up the issue of shipping bonds – which have traditionally supplied about 15% of the industry’s needs – but progress is still fairly slow.
One thought that the optimists favour is that there’s a two year time lag between commissioning a ship and getting it out to sea. On that basis, they say, the present cargo pricing situation is unrepresentative of the real medium-term situation. So you should get in now while the illusion of gloom persists.
But then again, you might argue, it’s surely no bad thing if the ageing pool of tanker and cargo capacity isn’t getting any bigger? Won’t that help to shore up flagging shipping rates by reducing the level of competition? Well, that, as they say, is above my pay grade. If some contrarian soul can explain it to the rest of us, I’m sure we’ll all be grateful.
The View From the Crow’s Nest
Considering all these interference pressures, it somehow seems a little trite for the BDI’s apologists to describe the index as a solid leading indicator that will give us a decent heads-up on the state of the equity markets as well as the economy itself. And yet there’s no doubt that many do regard it as exactly that.
What they’re less keen to admit is that an awful lot of private investors saw their finances smashed in the mid-noughties by that appalling gyration that we saw in our chart. Whether it’s shipping rates or bitcoins, credit default swaps or the Grand National, there’ll always be somebody who reckons he’s got the inside track.
And if, by any chance, the Baltic Dry Index theory has any substance to it, then we’re doomed, me hearties. The index is close to its all-time floor, and this year’s economic recovery has left it totally untouched. ‘Tis a perfect storm that’s coming. Time to double up on the doubloons.
An EIS Solution?
Just in case you think all this pessimism is a complete load of seagull droppings, there’s one new way of smoothing out the volatility, and of getting a 30% tax payback on the side.
A firm called Enterprise Investment Partners led the way back in March with the launch of an EIS company London Shipping Limited (“London Shipping”), which it said was “set up to acquire and operate a mid-size dry cargo bulk carrier, and to take advantage of the improvement in the shipping market.”
Yes, the offer closed for subscriptions at the end of March. But as an experiment in capital raising, with the added bonus of the tax credit, its advantages seem apparent. Not for your maiden aunt, but definitely worth watching out for similar products in the future. God bless all who sail in her.