UBS: Baltic Dry Scares Base
Baltic Dry Scares Base
August 13, 2009 1:26:50 AM
Author: John Reade
Declining bulk freight rates are worrying some clients and commentators, as the recent disconnection between base metals prices and the Baltic Dry Freight Index is quite unusual, as the accompanying chart shows. The two indices tracked each other quite well over the past eighteen months and - so the concerned suspect - the slip lower in freight rates herald imminently falling base metal prices. But there is no causal relationship between these two indices; rather they are in effect two different measures of demand strength for two different markets. The Baltic dry index is determined by supply and demand for bulk ore (and grain) transport. Demand is driven primarily by steel making raw material movements, whereas supply is a function of ship availability. While Chinese economic activity has been the common driver between steel making raw material demand and base metal buying this year, this should not make the two indices move in lockstep. We hear that there has been a slowdown in iron ore imports into China recently - unsurprising considering the large stocks of this material now held in China, although it may be also a consequence of the ongoing spat between Rio Tinto and China.
In addition, a summer slow-down is quite normal in the freight market, according to our in-house freight experts. Finally, there are a lot of scheduled ship completions in the second half of the year and this may be affecting sentiment in the market, although freight markets are in contango, suggesting that it is immediate softness in demand (rather than the threat of more supply) that is depressing freight rates. So while we are interested in the decline in the Baltic Dry, we are not reading too much into the decline - especially for base metals. Of course, this does not mean that base metals cannot correct: prices have moved sharply higher this year, in some cases well ahead of any fundamental justification, and this leaves the complex vulnerable to deterioration in risk appetite. If base metals do fall, however, we will not blame the decline on the Baltic Dry.