Must-know: Commodity prices and dry bulk shipping stocks

Inflation, the economy, and shipping
Commodity prices often rise when growth in demand exceeds growth in supply. This generally happens during the recovery or expansionary stage of an economic cycle, because producers are often unable to keep up with the rapid increase in orders. So inflation is often a positive indicator of economic health, which is positive for shipping companies that highly correlate with economic activity.
Inflation and producer price index
But commodity prices have been falling across the board lately, as China’s economic growth appears to be slowing. As demand remains weak and recovery gradual, inflation is nowhere in sight. China’s recent producer price index (which tracks the wholesale prices that manufacturers or miners receive), for example, continues to fall year-over-year.
Steel prices
The steel manufacturing industry—which is often seen as the bellwether of China’s real estate sector’s health and which mimics the country’s economic growth—also saw the effect of weaker economic growth pressuring its sales price. The spot price of the average hot-rolled steel sold in China has fallen from ~4,100 renminbi per metric tonne in January to ~3,436 renminbi in May, which represents a decline of ~16.9%.
Iron and coal prices
Prices for iron ore and coal, the two main raw materials used to make steel, have also fallen. While the price of imported iron ore at major ports in China stood near $150 per metric tonne in January this year, it has recently fallen to $112.5 in May—a downward move of ~27%.
Metallurgical coal
Although metallurgical coal prices have held up better (metallurgical coal is the type of coal used to make steel), they have also fallen.
•    Prices for prime coking coal in China at Pingdingshan (also known as Eagle City, located in the middle east of China) fell from 1,320 renminbi per metric tonne in January to 1,190 renminbi in May.
•    Prices for the same grade of coking coal in Yinchuan also fell from 1,160 renminbi to 1,030 renminbi over the same period.
•    Prices for Australian coking coal heading towards China fell from $140 per metric tonne to $127.14.
As a whole, prices for coking coal have fallen about 10% since January to May.
Although the year-over-year decline in commodity prices mirrors the negative growth in the producer price index (PPI)—which people often associate as a negative for shipping and which generally reflects weak or negative economic growth—falling commodity prices can also increase commodity shipments.
What made imports and prices diverge?
In 2010, iron ore imports barely rose compared to 2009 levels, after a surge in iron ore prices that nearly doubled (from ~600 renminbi per metric tonne of iron ore to ~1,200 renminbi). The surge was driven by worldwide government stimulus to save the global economy from further collapse. Although China’s economic growth started to fall in mid 2011 after the government raised the interest rate in order to rein in high price appreciation (inflation), traders started to import more iron ore due to falling iron ore prices.
Inventory buildup
This increase in iron ore import eventually led to an inventory buildup, with the amount of iron ore at major ports in China rising from 73 million metric tonnes to 100 million throughout 2011.
Prices and imports tagged each other from 2006 to 2009
While iron ore prices and iron ore imports both rose and fell in tandem from mid 2006 to the end of 2009, higher imports (driven by a robust demand for real estate in China that eventually led to a bubble) were the key driver of higher prices, instead of the other way around. After the United States’ financial crisis began and China rose interest rates to a decade high of 7.46% in order to burst the real estate bubble, economic growth fell. As demand fell, prices for iron ore fell. But even though iron ore prices were falling, traders weren’t confident in importing more iron ore, as they saw year-over-year sales growth for buildings collapse from 44% during the last month of 2007 to -4.44% two months later
The economy, imports, and shipping rates
When economic recovery or expansion takes place, shipping rates tend to rise, as more commodities are imported. Higher profitability among steel manufacturers will also make iron ore purchasers more generous with higher shipping rates. When things are good, people tend to be more generous and willing to pay more. Investors may then ask, what happens to shipping rates when imports rise due to falling commodity prices driven by lower economic growth, as seen earlier in this series? Thankfully, we have a recent case that helps explain what could happen to shipping rates in the current environment.
Shipping rates can rise when commodity prices fall or flatten
Back in 2011, China’s economic activity began to slow as the government raised its interest rate up to ~6.5% and restricted lending because of high inflation. But falling commodity prices prompted traders to import more iron ore, which actually drove shipping rates for Capesize vessels (the largest class size of dry bulk vessels that primarily haul iron ore and coal) higher for a while until industrial output collapsed later. While lower economic activity would often pressure shipping rates as demand falls, steel manufacturers are less sensitive to shipping rates due to their record low rate, driven by industry overcapacity. So, based on this analysis, it’s possible for shipping rates to rise when commodity prices fall or flatten—as long as economic output and profitability continue to grow.
Learn more about commodity prices and dry bulk shipping
To learn more about commodity prices and their significance for dry bulk shipping stocks, continue to Must-know: Commodity prices and dry bulk shipping stocks (Part 5: Industrial output and outlook), which will follow later today.
Source: Market Realist