URSABLOG: Cast Iron Facts?

There is a spring in the step of the dry bulk markets this week, especially in the larger sizes. Period charter rates for capesize and panamax/kamsarmax vessels have been popping, on the back of a shortage of supply of tonnage in the Atlantic. Numbers have been rising – whether it’s freight rates, iron ore prices, or ship values – and so sentiment is getting steamy again. Personally speaking my suspicion is that there is more animal spirits than hard numbers behind this.

Back in 1935 Keynes wrote that:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

In short, we take action because it feels good. I’m not saying that ‘spontaneous optimism’ is immoral or downright hedonistic (although as a shipbroker I am familiar with both), but positive sentiment is amplified when it comes after a long period of negativity, like now. I also suspect you will not see many references to IMO 2020 in this week’s market reports; no-one likes a moaner.

Speaking of market reports, for those with access to them, try playing market report bingo this week. For every market report you read, give yourself one mark each for the following references:

-         Vale fixing ships as production comes back on line after the Brumadinho catastrophe

-         The price of iron ore going up by over 70% this year showing increased demand, and restricted supply

-         Rising steel prices in China

-         Trade war fears easing

-         Geopolitical environment getting calmer

Give yourself a bonus point for anyone who manages to work in a tortuous reference to Brexit, or the Greek parliamentary elections. This will, I expect, be the general consensus this week.

My view, as you may expect, is slightly different. As I have written previously, the decline in the capesize market began months before the Brumadinho tragedy, and it was due to the oversupply of tonnage, particularly Valemaxes - sorry Chinamaxes – and the subsequent displacement of Atlantic vessels into the Pacific that have caused cape rates to be so low this year. This has been exacerbated by iron ore production cuts in Australia due to bad weather, where the government there now expects exports to be 814 million tonnes this year, rather than the 867 million tonnes as it had forecast earlier. The freight market improvement is a spike generated in the Atlantic as spot capes are fixed to clear out the stocks in Tubarao as Chinese demand increases in the expectation of a new stimulus package in the autumn. Or something like that.

Again, however, the real picture is a little different from the lazy shorthand that analysts and brokers employ as they repeat what they hear around them. The following article appeared this afternoon in the Financial Times, which I quote in its entirety:

China is investigating the cause of a steep rise in iron ore prices imported into China in an effort to “crack down on abnormal behaviour”, an industry association official has said.

Qu Xiuli, the deputy chair of China’s Iron and Steel Association, told a conference in Shanghai on Friday that “relevant departments” were looking into the recent jump in prices, according to Chinese state media reports.

“The drop in steel prices and the rise in iron ore prices have meant that the level of [Chinese] steel company profits has continuously declined and become hard for companies to digest,” Ms Qu said.

Iron ore prices rose to a five-year high on Tuesday, driven by stronger Chinese steel demand and lower supply from the largest producers, Brazil and Australia.

Steel prices in China have rallied this month following government-ordered cuts to production in the steel making hub of Tangshan in an attempt to reduce air pollution.

Apart from fairly sinister references to ‘relevant departments’, there seems to be confusion as to whether steel prices are rising or falling, and also whether demand steel or for iron ore itself is rising or falling, or whether the prices are just being manipulated. I suspect that in the coming weeks we shall see an announcement from the ‘relevant departments’ in China announcing a new regulation forbidding or restricting speculation in iron ore futures. But the interesting point for me is that according to this, steel prices have risen not because of a fundamental rise in demand for steel, but because of a fall in steel supply due to the production cuts in Tangshan. Underneath all the positive sentiment the facts seem to point the other way for shipping: demand for iron ore volume is less due to steel production cuts and supply of iron ore in terms of volume will be less due to bad weather and other related problems. Neither bodes well with the freight market for capes in the medium term. Therefore, to me at least, this could be a spike based on rumour and short-term necessity rather than coming the arrival of the long awaited sustainable and profitable freight market.

Richard Thaler, the superstar of behavioural economics and Nobel prize winner, a gave a lovely example of how sentiment (and incomplete information) can drive prices. On December 18 2014, President Obama announced he was going to lift several restrictions against Cuba. Almost immediately, the value of a closed end fund (i.e. closed to new investors after a certain amount of money is raised) called the Herzfeld Caribbean Basin Fund increased by almost 100% in a day. The Herzfeld Caribbean Basin Fund had 69 percent of its holdings in US stocks, with the rest in other foreign stocks, predominantly Mexican. However the fund had given itself the ticker ‘CUBA’ despite the fact it held no Cuban securities, indeed it has not been legal for any US company to invest in or do business with Cuba since 1960. The reason for the rise was of course the market looking for value as quickly as possible following President Obama’s announcement. A fund with a ticker ‘CUBA’ seemed an obvious choice, even though it was the wrong one. The interesting thing for me is that even though the price faded quickly after people realised that ‘CUBA’ had nothing to do with Cuba, it still took year for the price to revert back to ‘normal’ behaviour.

Price - and freight rate - movements can be moved by sentiment which is a consequence of human behaviour, animal spirits, ignorance or whatever you want to call it. This does not necessarily mean that the rise in the freight market is a chimera: it is very real and welcome for owners who have had ships to charter this week. It is the markets behaving as they should, efficiently in response to all known information at the time. That sentiment is a big factor in all this does not make it less efficient.

But in a market in need of good news and direction owners – and brokers for that matter – will ride this wave for as long as they can. But the wisest advice I heard this week was from a client of mine discussing his next purchase. “It is encouraging, Simon” he said, “but I’m going to wait another week or two to see if it’s real.” In the end timing – in shipping as in life – is everything: when we take a decision to act can be as important as what that decision is. For what it’s worth I do think the tide has turned for the dry bulk market, but my reasoning has nothing to do with iron ore per se, but more on that next week.

Simon Ward

www.ursashipbrokers.com