Looking beyond the near-term weakness in dry freight

Looking beyond the near-term weakness in dry freight
Published: 26 July 2010

The Baltic Dry Index just experienced a severe downward  spiral, undergoing the longest consecutive decline since 1995, writes BofA Merrill Lynch in a recent Global Research report. Partially reflecting the simultaneous economic slowdown in the US, Europe and China, dry freight prices recorded a 60% collapse in just 35 days. A combination of lower iron ore imports into China, slower coal activity,  easing port congestion and a heavy fleet delivery schedule pushed dry freight  rates lower. Still, the  BDI reclaimed about 8% of its  losses during the past week. While freight rates could rebound  from the current very low levels, we believe the upside  to the BDI is likely capped  near-term. A weaker-than-expected economic  recovery and excess shipping capacity argue for  low spot freight  earnings relative to historical  levels, at least for the next six months.  


 The sharp reduction of China’s iron ore imports has been weighing on freight prices. Iron ore imports into China fell by 15%  YoY in June, relative to 80% yearly growth last December. This demand slowdown is not just confined to China. Reflecting the more sluggish  demand environment and the expiry of fiscal  stimuli, steel prices across the world have  turned south. Moreover, the seaborne thermal coal market also started to weaken lately. BofA view the current demand deceleration as temporary and expect seaborne coal and iron ore imports into China to improve given the high cost of domestic production.

Looking farther out, BofA remain more positive for 2011 and beyond as it expects demand growth to catch up with supply growth. Assuming a double-dip can be avoided now, strong EM fundamentals could provide a catalyst for a  strong rebound in dry bulk trade. While short-term fundamentals are poor, ships can barely break even at the current rates and we expect a high  slippage rate for 2011. Hence, long-dated freight contracts  are likely to be on a gradual appreciation trend. The current environment  could serve as a good entry-point for long positions in the back of the  curve. While the capsize curve is in steep contango in the front, long forward freight positions benefit from backwardation.

Source: BofA Merrill Lynch Global Research report