The Baltic Dry Index: What's Driving It Up?

The Baltic Dry Index (BDI), a shipping index considered one of the most reliable global economic indicators, has been surging up for 17 consecutive days as of Feb. 11, 09. It's not often that something just keeps going up for 17 days. The BDI’s strong rally has caught a lot of people’s attention. However, dry bulk shipping stocks like DryShips (DRYS), Excel Maritime Carriers Ltd. (EXM), Eagle Bulk Shipping Inc. (EGLE), Genco Shipping & Trading Ltd. (GNK), TBS International Inc. (TBSI) and Navios Maritime Holdings Inc. (NM) plummeted instead of moving with the BDI. So, what's going on here? Let me digress a bit before talking about the fundamentals of shipping.

Despite a 17-day rally, most people remain skeptical about the outlook of the BDI. In a recent post, Trader Mark asked "What's Really Going On." Most believe the BDI rally will be short-lived, so when BDI finally dropped for two days, Bespoke Group declared: "BDI rally is DEAD!"

The skeptics are wrong because they only read the news headlines and have failed to study the real reasons the BDI plummeted in 2008 and for its recent, strong surge. The skeptics failed to predict that the rebound in the BDI would be soon and so powerful, but I correctly called the bottom and also called for the BDI's imminent and powerful rebound. Therefore, I am comfortable to call the skeptics wrong and predict the BDI’s continued surge.

Trader Mark quoted from a Lloyd's List article, which expressed skepticism that the freight rate surge could be short lived. These concerns raised need to be carefully addressed:

1. Recent freight rate surge resulted from China restocking the iron ore, import inventory. It will slow down as there is no evidence of increased steel demand.

Well, surely, there is already strong evidence that China's economy and demand on raw materials is recovering rapidly. Pay more attention to news from China!

2. Despite of a remarkable raise in percentage, the BDI at a current 2000, is still far below the all time high last August at 12000.

Come on! No one expects the BDI to return to high levels overnight. Nothing goes straight up or down. The BDI did not fall from 12000 to 666 overnight, and no one expects it to return to 12000 tomorrow. The surge from 666 to 2000 in just a few weeks is a more remarkable recovery than any one can expect. In geometric scale, the recovery is already at 38%. The jump from 666 to 2000 is a tripling, and another tripling would bring it to 6000 - just a leap short of 12000.

3. A huge backlog of new ship orders exits. New ships entering service in 2009 and 2010 could expand the global dry bulk fleet by 40% and cause capacity oversupply. Please refer to this article for details.

However, we should not take data out of context, as the old ships are being scrapped at the same time new ships are entering service. During the recent shipping boom, almost no scrapping took place as ship owners extended the services of old ships to profit from high shipping rate. Now that shipping rates have fallen, there is a sudden rush to send all the old ships to scrap yards in order to bring in cash liquidity and enhance the balance sheets. In just two month, four million DWT tons worth of ships were sent for demolition, which is more than the last few years combined. Scrapping old ships is surely faster than building new ships!

The numbers from the UNCTAD review need to be taken in context. As of end of 2007, there were 10053 new ships and 495M DMT tons on the order books, including 222M DWT tons of dry bulk carriers. That was 72 times higher than it was in 2002 - 72 times! The global dry bulk fleet is about 600M DWT tons in size, so assuming a new ship takes two years to build, 222M worth of new ships will be build in two years, not counting scrapping, the increase of global fleet will be 222M/600M = 37%. That's how some analysts figured the 40% increase.

However, the number is wrong - the average ship lifespan is about 20 years. So normal scrapping, due to aging, would remove 10% of the fleet in two years. The increase in the scrapping of over-age ships could remove up to 20% of the fleet in two years. Even if all of the new orders were built, when you subtract 20% of the scrapping, the global fleet would only increase 17%.

However, don't expect 222M worth of new ships in the next two years. Due to low shipping rates and a lack of financing, more than one-third of ship orders have already been cancelled. More are being cancelled or delayed. Read the Hellenic Shipping News - shipyards around the world are in very bad shape, and many could go bankrupt if they don’t get any help.

Question: If shipyards had normal business in 2002, and their order book is 72 times bigger than the 2002 level, then why are shipyards in bad shape now? Even if 30%, 50% or even 90% of orders were cancelled, the number of remaining orders would still be much larger than the 2002 level - not to mention the profit from cancellation fees. There are not a lot of shipbuilders in the world, and global ship building capacity could surely not have increased 72% from 2002 levels as there is not enough space, materials, building capacity or financial backing to build 10,053 ships at the same time, and then deliver them within two years.

Someone must get the numbers terribly wrong. In any case, you can be rest assured that if shipbuilders are on the brink of bankruptcy, then we will NOT see any rush of new ships joining the global fleet in the next two years. It is more than likely that the global fleet will shrink, instead.

Thus, I encourage people to take advantage of the recent shipping stock plummet. Buy shipping stocks such as Excel, Eagle, DryShips, Navios, Diana Shipping Inc. (DSX), GNK, TBSI, OceanFreight Inc. (OCNF), Safe Bulkers Inc. (SB) and Paragon Shipping Inc. (PRGN). I have not looked at all of them in detail, but based on my own research, my personal favorites are EXM, EGLE, DRYS and NM. Please do your own due diligence and research.

Disclosures: The author holds big positions in shipping stocks EXM, EGLE and DRYS. I do not own other stocks mentioned.

Comments

[H.J. Huneycutt:]

While the index is up, I think you might be reading too much into it. Historically speaking, it's still at highly depressed levels. It's not really a surprise that it's up as its dramatic collapse was overdone --- but that doesn't mean the near-term outlook for drybulk is good or that many of the shipping companies will suddenly surge back into the black.

If you're buying into drybulk right now, you should be looking for value. There are different ways to price the companies but I wouldn't buy into any company selling above their net tangible assets right now and I'd only buy into companies that are selling significantly below net tangible assets. November and early December provided great long-term buying opportunities for drybulk stocks; I'm not so sure that's the case at the current price levels; though, I do like a few companies in the sector:

TBSI looks like the best play to me right now. They don't have too much leverage and they looked to still be priced relatively cheap, even if they are up off their 52-week lows significantly. DSX might be a good long-term bet, but I wouldn't buy into them unless the price dips back down to the $10 range again. At $13, I don't necessarily believe the risk-reward trade-off is appealing.

DRYS won't be worth much if they go bankrupt - and that's a distinct possibility. They are one of the worst managed outfits out there. As for a lot of the others, I wouldn't buy right now but if the sector experiences another significant dip, it might not be a horrible idea to set up a diversified portfolio of drybulk stocks so you end up protected against the companies that end up going under.

Feb 18 03:03 PM

[Mad Hedge F...:]

Early reflationary plays were flashing the green light today. Copper was limit up in Shanghai to a two month high at $1.61/pound. Also, take a look at the Greek shipping firm Dry Shipping Inc. (DRYS), which I recommended in November at $3. It soared 460% to $17, fell back to $5, and is now up to $6.30 on news that they successfully rolled over $800 million in debt. It is another great time to make a second visit to the trough for (DRYS), in case you missed it the first time. This shows you that successful refinancings are going to have a huge positive impact on stock prices as we bump along the bottom here, and will be a major market play for the rest of the year.

Feb 21 09:08 AM

[Conan the B...:]

Come the Middle of February, 2009 Full Disclosure: EXM, EGLE, DRYS.

No mention of anything at all related to Silver or PGM.

Apr 09 12:56 PM

[Mark Anthony:]

Conan:

When the article is published on Seeking Alpha it was cut short for better readability as it will concentrate on dry bulk shipping exclusively. I did hold a huge position in SWC continuously during the time. You may want to read the original flavor of the article on my blog, whcih is more complete:
stockology.blogspot.co...
I do not have to make a laundry list to to mention everything in my portfolio in every one of my articles published on Seeking Alpha.

May 22 03:30 AM

[Mark Anthony:]

To put some numbers into context. This link provides estimate of global ship building capacity:

www.mgn.com/news/daily...

In second paragraph, it estimate that in 2009, global ship building capacity will reach 50 million DWT tons. Please note, this is global ship building capacity of ALL ships combined, including military ships and river bound ships. If only 1/4 or 1/3 of all new build ships are dry bulk ships, then we will be talking about capacity of adding roughly 13 to 17 million DWT of new dry bulk ships per year.

This is a very small number compares with existing global dry bulk fleet of roughly 600 million DWT tons.

The so called new dry bulk ship glut is way overblown. There may or may not be a lot of new order ships on the order books, but the global ship building industry surely will not be able to push out too many new dry bulk ships per year to dilute the fleet enough to cause a problem.

Dec 10 05:18 PM

[ramisle:]

Mark Anthony is a complete lying phony.
You were told months ago that there is a huge difference between 50 million cgt. (compensated gross tons), and 50 million DWT. Obviously, since you are still trying to fool people about it, you are a fraud, and should be exposed.
Dozens of Independent shipping publications have published the amount of new ships being built, and the amount being demolished. You have never substantiated any of your hair brained theories.
drewry.co.uk
weberseas.com
brs-paris.com
cotzias.gr
worldyards.com
lloydslist.com
fearnleys.com
nilimar.com
platou.com
drybulkindex.com
steelguru.com
tradewinds.no
Do some research for once.
You have been dead wrong since you started pumping dry bulk in January, it's time to admit you were wrong. Thousands of stocks are up, you aren't, stop trying to deceive people about dry bulk and go back to pumping your sad palladium stocks.

Dec 10 08:52 PM