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By: Ahmed Ishtiaq

Shipping companies had an interesting end to the week. Almost all of the players in the industry gained on the news of recovery in the global shipping industry. Shipping stocks are relatively cheap at the moment, and some of the stocks are trading close to all time lows. DryShips (DRYS) went up approximately 25% at the end of the week. Its peers also recorded substantial gains; Eagle Bulk Shipping (EGLE) and Excel Maritime (EXM) went up 27% and 29%, respectively.

Although the shipping industry is not expected to recover for at least another year, the investors and traders have found news to make short-term profits every now and then. The recent rally by shipping stocks is an example of how investors are making short-term profits from this volatile industry.

Short-term gains or long-term bets?

The shipping rates showed a recovery and went up, driving the stock prices high. Investors found an opportunity to make short-term gains on positive news about the industry. As I mentioned in my previous article, shipping rates have come down to record low levels due to the oversupply of vessels in the industry. Some companies are finding it hard to break-even due to the low shipping rates. In the current circumstances, positive news about the shipping rates was sure to get investors excited. However, it should be kept in mind that it does not solve the key issue in the industry. Currently, the industry has more vessels and less demand. Furthermore, the vessels are growing at a faster pace than the demand.

At the moment, the biggest driver for the shipping industry is increased spending by the Chinese government. As a result of increased infrastructure spending, the Chinese demand for iron-ore has improved slightly. China is the biggest importer of iron-ore while an increase in demand from China is encouraging; it does not mean the industry will make a quick turnaround. Conditions in Europe are still gloomy, and the European economies are not expected make notable recovery over the next year. The shipping industry is hugely dependent on the overall global economic conditions, which are not very impressive at the moment.

As a result, I believe the gains recorded by the shipping companies are short-term. Investors have used a piece of positive news to good effect and made substantial profits. In the long-term, I maintain my previous view that it will take some time for the shipping industry to recover. Most of the shipping companies will struggle to make a profit, and stock prices will be volatile. It will not be surprising if these shipping companies lost these gains over the next few days. I believe the shipping industry will remain volatile for at least six months, and these stocks may face problems consolidating recent gains.

Baltic Dry Index, A Better Indicator?

I believe Baltic Dry Index is a better indicator of the direction of the shipping industry. A look at the index shows that it is sitting well below all time high it has enjoyed in the past. At the moment, Baltic Dry Index is around 700, not much higher than all time low level of 647. So, fundamentally, there has not been any substantial change in the market. The rally has been a result of short-term trading based on positive news solely. Another interesting piece of news about the industry appeared on January 01, in Financial Times. According to the Financial Times, shadow banks and hedge funds are showing a keen interest in the shipping industry.

The hedge funds and shadow banks are buying debts of the distressed companies. Hedge funds, shadow banks and private equity funds have a history of taking advantage of the companies in distress. According to FT, Oaktree bought $800 million worth of shipping loans from Lloyds on a significant discount. Furthermore, the hedge funds and shadow banks are also buying vessels and tankers from these companies. In addition, private equity arm of Oaktree invested $200 million in General Maritime before the company filed for bankruptcy. Later on, the fund had to put in an additional $175 million. Bets by hedge funds and private equity firms may have also triggered the price movement.

Summary

DryShips have shown considerable recovery over the past week, and a gain of over 40% since I last wrote about the stock is hugely impressive. However, I do not believe this hike in stock price is an indicator of a recovery. DryShips stock will remain volatile, and the company will have trouble reporting a profit for at least two more quarters. At the moment, its ultra-deep sea drilling arm OceanRig (ORIG) is keeping it afloat and making up for the losses. However, DryShips will not be profitable on its own in the short-term. I believe this stock is only suited to investors with high risk tolerance. On the other hand, I do not believe the company is doomed. I expect the company to make a turnaround; however, a solid turnaround is not close at the moment.

Source: DryShips: Recent Gains May Prove To Be Temporary