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Second Level Thinking And A Left For Dead Sector

|About: Invesco Shipping ETF (SEA), Includes: STNG

I talk a lot about using second level thinking in investing and speculating. What do I mean when I say this?

Most people look at a situation and the obvious cause and effects of that situation. I like to look beyond the perceived obvious explanation and dig deeper. This way I may be able to get an advantage or uncover a speculative opportunity that the masses may have missed.

Legendary market commentator Don Coxe used to say don’t look at the page one stories as they are already priced in. Look at the page twenty story that will move to page one. That gives you the edge.

An example of this is the shipping industry. When I am talking shipping stocks, I am referring to ocean going transport via ships. Currently most shipping stocks are in a massive bear market. Shipping is a massive cyclical industry.

It goes through cycles of high shipping rates which encourages new supply of ships to be brought on stream which of course crushes shipping rates and then leads to bankruptcies and restructurings.

A period of low rates causes less ships to be brought online and then supply tightens as older ships are retired. Rates begin to rise and rinse and repeat. A very cyclical industry.

Currently the shipping industry is in a ten-year bear market. This bear market has been exacerbated by the perception that the US-China trade war is bad for shipping.

Thinking a trade war is bad for shipping is first level thinking and is incorrect. Disruptions in trade increase the number of miles goods need to be shipped. For example, China may ship items to Vietnam where they are then reloaded on US bound ships. It seems counter intuitive, but it is true.

The other big news in shipping is that a new environmental standard called IMO 2020 comes into effect on 1/1/2020.

IMO 2020 stipulates that ocean-going ships need to stop burning high sulfur bunker fuel and switch to low sulfur bunker fuel. Low sulfur fuel is more expensive than high sulfur fuel. There are ways around some of this cost. Ship owners can install a device called a scrubber that allows the burning of high sulfur fuel. The scrubber removes the sulfur dioxide emissions.

The problem with this is that it is expensive to install a scrubber and it removes the ship from service while the ship is being refitted. Is it worth installing a scrubber on a twenty-year-old ship? Probably not and these older ships will get scrapped.

This further lowers the supply of ships boosting rates.

In addition, some owners will choose to burn low sulfur fuel and then “slow steam” their ships. Slow steaming is when you slow down the ship to save fuel. This works but it makes the voyage longer and again reduces the amount of ships that can carry cargo, thereby boosting rates.

Our friend Harris Kupperman has talked about shipping extensively at his blog Adventures in Capitalism which can viewed at this link.

Kuppy also joined “The Market Huddle” last week and discussed why he is bullish on shipping and a Greece update.

It does pay to look beyond the headlines and the most obvious explanations for various events. This can lead to profit opportunities that overlooked by the general masses.