URSABLOG: This Little Piggy Went to Market

Between 2006 and 2012, the super cycle years, I spent a lot of time in China. I was riding a wave - and then cresting it - as the demand for both secondhand ships from China and newbuildings from Greece rose, fell and rose again. The memories of that time are not just wrapped in MOAs and newbuilding contracts, although indeed that was true (and very nice it was too) but also of their renegotiation as the super cycle was reset after the start of the financial crisis in 2008.

Other memories remain too, particularly those of the pace of change. It seemed that every time I arrived in Shanghai the skyline had changed: a new building had gone up and old ones were being cleared away. Society was changing too, particularly evident when visiting shipyard in the more rural areas. It was clear that the old methods of farming were changing, but what was particularly striking was the contrast with the old and the new, in close juxtaposition with each other: building sites torn apart by modern machinery, new train lines slicing through the countryside whilst local farmers carried on, pulling hand carts laden with vegetables along the hard shoulders of newly built highways.

On one trip, after a tour of shipyards in Jiangsu and around Nanjing we were being driven back to Shanghai, and tired of talking and checking my BlackBerry, idly looking out of the windows I started to pass the time by counting the lorries carrying pigs to market. I stopped after fifty; I was amazed by the quantity but the demand for pork in the city was insatiable. One of the features of a rapidly urbanising economy is the rise in demand for protein, and a change of eating habits by a growing middle class. Meat is an easy way to provide nutrition for the city, nothing is wasted but once you develop a taste for it, it becomes hard to go back the vegetable diet you were used to, at least until you need to diet. The growth of fad diets belongs to a later stage of economic development.

So the growth in demand for meat, like that for steel and cement, are signs in the development of emerging markets. Pigs were also important in the growth of economics, in particular our understanding of something we know only to well in shipping: economic cycles.

One of the first to put numbers down on cycles was an American farmer called Samuel Brenner in 1876. He was tracking pig prices in order to try and work out how much corn to grow each year, rather than plant the same every year and hope for the best. As we know from each grain harvest, the price varies depending on a number of different variables, and can’t be just be discovered by ‘demand’ and ‘supply’. Weather, famine, cheaper competitors, more expensive competitors, I won’t bore you, but refer you to the models used by Cargill and other agricultural behemoths to advise their farmers.

Back then, Samuel Brenner, using pen and paper, made the simple observation that there were seldom two years where the average price of pigs stayed the same, which was problematic because farmers had to try and predict where prices would be in order to decide how many pigs to rear. Let’s look at the classic supply and demand model:

It helps to an extent. As the price increases so does supply. As supply decreases prices go up. But what he noticed was that the sweet spot, equilibrium, was never reached. As the conditions, and therefore the demand and the supply, changed it was very difficult to get predict the right number of pigs to rear. Brenner came up with the following model, the cobweb model.

Q1 does not satisfy demand, so the farmer rears more, Q2, but this over shoots demand and the price falls. Consequently the farmer modifies his position and Q3 is the nearest shot to the target. If there was a stable environment each try got a bit closer. But when there was an outside shock, a disease for example, or a shortage of fodder, the gradients for the supply and demand graph would change, or if there was a change in demand, the curve would shift altogether sending the quest for equilibrium out. Therefore the market had to start again; equilibrium would never be reached – prices would always be unpredictable.

Brenner was growing corn, the fodder the pigs would eat, so his task was more complicated. The demand for corn was derived from the demand for pigs, and the demand for pigs was related to a whole host of different factors. The more factors, the more complicated it becomes: a small shift in one of these factors changes everything, and it could be a factor that no-one particularly keeps an eye on, until it assumes importance, and then that’s all everyone thinks about.

Let’s come back to the present day. The world has changed since the late nineteenth century: it’s more connected, and commodities are traded and travel the world with a hugely complex network of systems. However, if you change corn for soybeans, the above model looks frustratingly similar.

Soybeans are grown in huge numbers by major exporting countries, like the US, Brazil, Argentina and so on, to satisfy the needs of major pig producers, like China, who have a fluctuating demand to feed their urban (and rural) populations. Everything is going well, managing the usual effects of the four horses of the Apocalypse: Death, Famine, War and Conquest. Then a fifth horse, an orange horse, called Trump rides into the fray, confusing everyone. Tariffs are imposed, a trade war escalates, and farmers in the US, Brazil (and Ukraine and Russia) are wondering what to grow, and in what quantity.

The freight market, our market, is even more confused. One step further derived from the demand for souvlaki (or it’s Chinese equivalent), we have to factor in the sea, distances and the supply of and other demands on the fleet of dry bulk carriers. No wonder the freight market is volatile and prospects are unclear.

Recently, China has encouraged companies to buy “a certain quantity” of pork and soyabeans from the US and they will be exempted from additional tariffs, apparently referring to duties imposed since the start of the trade war. China did not state the amounts that will be purchased. This pledge came hours after Trump said he would consider doing an “interim deal” with China. This is welcome news of course to alleviate the worst effects of the trade war, but hardly makes it easy to predict the amounts to be planted, let alone shipped into China, both of grain and of pork. And it could all change with another tweet.

Evidently these are different times from 2007. Then China was in take-off mode, and its appetite for everything was voracious. We live in a far more complex world now. If the demand for soy beans is derived from the demand for pork, and the demand for ships from charterers is derived from the demand for soy beans (or at least a significant part of it), and the demand for buying ships is derived from what the charterers think, we can see how investment decisions are difficult right now. A small part of the overall picture can change, and then everything changes, for better or for worse, and we will only find out why in retrospect.

We can not go back in time, and the heady days of 2003-2012 will never be repeated. The skyline of Shanghai is more or less fixed, the change in Chinese society is more evolutionary than revolutionary, and hopes that stimulus will come to the rescue of the dry bulk market oversimplifies the increasing complexity of the Chinese economy. Think about this when you next tuck into a bite of pork (or chicken, or tofu): like it or not you are a small, but significant part of the global dry cargo chartering market. Bon appétit!

Simon Ward

www.ursashipbrokers.com