A little over a quarter ago this update on the Baltic Dry Index was posted here. Today the graph looks like this:


A very useful comment last time pointed out that it is also worth watching forward freight agreements (FFA), derivatives used by shippers to (amongst other things) insure against rate volatility, when guessing the direction of freight rates. In December, Q1 2008 FFAs were in contango versus spot - at odds with the message of the then version of the above graph. One quarter of actual data later suggests the BDI/10 year Treasury measure was the better leading indicator.

But this is deceptive. FFA data is not strictly comparable to an index: they are traded against routes rather than composites; and they are driven by expectations, rather than real-money-down as with the BDI and Treasury data. As of yesterday all routes on available 2008 contracts were in either very gentle contango or very gentle backwardation versus spots. Or sometimes both depending on the period considered (ie a gentle hump for a given route graph). Prices into 2009 and out were well below spot.

The point, however, is that over the next quarter FFAs show broadly steady rates whilst the BDI/Treasury measure shows them dropping again. How either indicator, one short term the other shorter still, can be used to inform the commodity super cycle and decoupling debate is questionable. Moreover, there are additional considerations when interpreting both data sets - but especially the BDI.

China has embarked on staggeringly large investments in shipyard construction which, if all completed, will double shipping capacity by 2010. How this supply side factor will impact freight rates is a riddle, wrapped up in mystery, inside an enigma. Potentially, it will badly distort the underlying reality, or surreality depending on one’s level of free-market dogma, of the super cycle picture as it is conveyed by the level of the BDI.

And, over on the demand side, China’s growth as a steel and cement exporter; a coal importer; and its huge iron ore requirements (around 12% of the BDI by itself) have transformed the index to a large degree into a metric of the poster-comrade’s economic health. It is ironic that shipping, previously a prime example of a highly economically liberal industry, is now more or less a plaything of the world’s largest centrally planned economy. Not that ship owners are complaining about it.

But the overarching prop of the commodity super cycle case – and that for the decoupling thesis – is not merely that China is buying a lot of "stuff". It is the idea that political pressure to deliver, particularly in China and India, social improvements in public goods and services has lent the commodity cycle an unstoppable long term momentum. This is seductive, but it does not necessarily equal decoupling in the short and medium terms.

The argument is, in fact, a simple variant of the too-big-too-fail thesis and is as much an act of faith as an exercise in logic. In blunt terms, be it even a cycle within a super cycle, there are limits to compensating a declining export sector by stoking domestic demand. And, as for the longer term, assuming the various political landscapes as constants - as the super cycle thesis appears to – has been shown many times by history to be an unsteady foundation upon which to build.

Still, here's hoping this one holds.

Sources: Clarksons Shipping Intelligence; Imarex (International maritime Exchange); Barry Parker, bdp1 Consulting Ltd

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