A key factor to monitor is the Baltic Dry Index, the shipping industry benchmark for dry bulk shipping rates. The BDI is down over 50 per cent over the past year. Recently, however, has bounced back sharply, up 145 per cent between 8 December and 6 February.
It is difficult to obtain direct exposure to the BDI. Historically the Russell Global Large Cap Shipping Index (as tracked by ETFS Russell Large Cap Shipping Fund – SHIP) has had a close correlation to the BDI. Since 8 January, however, it has lagged the BDI quite substantially. With the BDI gaining momentum – up on average 5 per cent per day between 4 February and 18 February – if the historical relationship holds between the BDI and SHIP, there appears to be scope for SHIP to bounce.
The BDI broke through 1000 on 27 December for the first time since late October. BDI Index levels of 1000-2500 are the approximate range of estimates for break-even rates on dry bulk shipping according to UOB KayHian. SHIP is a useful market proxy for the BDI: the rolling monthly correlation of annual returns between SHIP and the BDI has averaged 0.5 in the 18 months to January. This positive correlation is strongest in high BDI growth phases. SHIP has underperformed the BDI by 95 percentage points between the start of November and 6 February as equity markets have remained under pressure.
Periods where SHIP returns are falling and underperforming relative to BDI tend to be followed by periods of outperformance. SHIP outperformed the BDI by 64 percentage points in the 3 months following the trough in SHIP returns in August 2006. SHIP and the BDI fell 54 per cent and 92 per cent respectively over the second-half of 2008, further than many other asset benchmarks and commodity prices. The S&P 500 fell 29 per cent over the second-half, while commodity prices, as measured by the DJ AIG Commodity Price Index, were down 50 per cent.
Some consolidation in fundamentals
Market confidence that Chinese demand for raw materials is consolidating has been boosted recently by an increase in Chinese manufacturing PMI and stimulus plans over the next two years. China plans to spend $586bn (approximately 7 per cent of GDP) on major infrastructure projects. Shipping brokers report that demand for the largest dry bulk shipping carriers (Capesize) is slowly recovering as the Chinese run-down in iron ore inventories slows. In addition, the proportion of idle bulk haulage ships has been decreasing as Chinese demand has stabilized over recent weeks.
Scope for shipping equities to bounce
The BDI which tracks dry bulk shipping prices has picked up strongly over the past few weeks, after falling sharply through the second-half of 2008. The Russell Global Shipping Large Cap Index of shipping equities (available only through the ETFS Russell Global Shipping Large Cap Fund (‘SHIP’) has traditionally had a strong correlation with the BDI. More recently, however, SHIP has lagged the BDI, indicating that if historical relationships hold, there is scope for SHIP to bounce.
Daniel Wills is senior analyst at ETF Securities. The views expressed here are his own. No recommendation is inferred.