It has been in the air for some time that the iron ore prices are witnessing a recovery. With prices of iron ore hovering over $130/ton (for 63.5 Fe grade), people are asking this question: Have we seen the bottom in the iron ore prices?
The future of Iron Ore
A couple of days ago, I read an article that claimed that the iron ore prices are expected to rebound in the next year. Moreover, the sell-side is continuously stressing that the iron ore prices are expected to witness a sharp rise in the next year. Goldman Sachs expects a robust recovery of the iron ore prices to $138/ton by the end of the first half of 2013. Similarly, Credit Suisse is also bullish on the iron ore prices for the next year. Steel guru commented on this trend in the following manner:
Led by strong anticipation of inventory pile up by steel mills as the recharged industry with strongest PMI of 50.9 in 14 months and equally resounding demand in retail, auto sector and infrastructure led the brigade.
There is absolutely no doubt that the iron ore prices are currently witnessing a rise. However, I believe that the so-called "rebound" (this increase in prices) is only temporary and the prices will come down in the second half of the next year. The evidence for this is that the economy as a whole is not growing (explained below) even though there are certain growth patterns that are showing that a recovery in the economic growth rate might be in the cards. However, there are some other statistics that are sending bearish signals to the market:
- The real estate sector in China is giving an improved outlook for the year. Accelerating construction activity on both existing and new projects is expected to push up the demand for steel (iron ore is a key ingredient in the steel-making process).
- The fixed asset investment in China is steady and is benefitting the steel demand.
- Shanghai rebar future prices have hiked, signaling an improved market for the steel mills.
- The iron ore stocks at the Chinese ports have been drawn down to low levels. Therefore, the piling up of inventories will mean an improvement in the demand for iron ore.
- The housing indicators seem to show a bullish trend but they have been extremely volatile in the past, which means that we should not rely on its trend.
- The construction equipment sales remain depressed which means that the housing recovery may not be strong after all.
The key aspect to keep in mind is that the key capital and consumer goods sector continue to suffer an overhang of inventory. This means that the overall economy is not witnessing a surge in demand from the final consumers. The sluggish growth in the auto production is a prime example of this notion.
Therefore, I am bearish on this 'recovery' because of the fact that a holistic view of the macro environment in China, the biggest consumer of steel in the world, is not giving a bullish picture at all. A rise in demand in the steel sector vs. a stagnant demand in some key sectors of the economy shows that this might be only a temporary recovery in the iron ore prices. The main factor at play is the fact that long product inventories, mainly in the construction and infrastructure, appear to be in the early stages of a seasonal restocking cycle. This cycle normally starts in the end of December and finishes by the end of March. Therefore, we can expect a temporary recovery in the iron ore demand till the end of the first half of 2013.
Dry bulk shipping stocks
A temporary rise in the iron ore demand will also lead to a temporary rise in the demand for the Capesize vessels and eventually bring incremental revenues for the dry bulk shipping companies. Let's briefly touch upon how different dry bulk companies will be affected by the temporary rise:
All of DRYS's Capesize vessels are on long-term charters. However, this does not necessarily mean that DRYS will not benefit from a surge in the Baltic Capesize Index (BCI). We should also consider how many of the charters are actually expiring by the end of this year or by the start of the next year.
George Economou, the CEO of DRYS, stated:
The shipping market continues to be severely depressed. Both tanker and dry bulk spot charter rates have been at historic low levels - well below cash breakeven rate - for some time. Unfortunately this is coming at a time when our lucrative legacy charters continue to expire on a staggered basis. We have contract coverage of 33% and 22% of the calendar days for 2013 and 2014, respectively.
This means that the vessels with long-term charters expiring before the end of the first half of 2013 can benefit from a surge in the Baltic Dry Index (BDI). Now we need to analyze how many of the Capesize vessels owned by DRYS will actually be free in the first half of 2013 to benefit from the surge:
The company owns a total of 36 vessels; 10 Capesizes, 24 Panamax and 2 Supramax vessels. The chart shows us that only one Capesize vessel (Partagas) will be free by the end of the first half of 2013. This means that DRYS will not be able to benefit directly from the temporary surge in the BCI next year.
Genco Shipping (GNK)
GNK owns a total of 53 vessels; 9 Capesizes, 8 Panamax, 17 Supramax, 6 Handymax and 13 Handysize vessels. Therefore, the Capesize vessels account for almost 17% of the overall fleet of GNK. As I have already mentioned in my previous articles on the dry bulk industry, most of GNK's vessels operate on an index-based system (to understand the index-based system, please refer to my previous articles). This chart taken from GNK's quarterly statement shows that most of the index-based charters for the Capesize vessels are expiring by the end of this year or before the end of the next year's first half:
Therefore, GNK is expected to benefit from a short-term rise in the iron ore demand.
Diana Shipping (DSX)
DSX owns 8 Capesize vessels which form 32% of its overall fleet. The following chart shows GNK's Capesize fleet:
I have already mentioned in my previous articles that 100% of DSX's fleet is being operated on long-term charters. The chart shows that 4 of the 8 Capesize vessels are expected to get free in the first half of the next year. Therefore, DSX is expected to benefit from a rally in the BCI in 2013.
Navios Maritime (NMM)
NMM owns 7 Capesize vessels, all of which operate on long-term charters. The Capesize fleet forms almost 33% of the overall fleet.
The chart shows that no Capesize vessel can be used to benefit from the expected rally in the BCI next year.
It is important to remember that this article only recommends the investors to buy these stocks to benefit from the short-term rise in the demand for iron ore. Otherwise, the current dynamics of the dry bulk industry requires a more rigorous analysis to short-list those stocks that can appreciate in the long-run.