Despite some calls that a commodities bottom is nigh (see Marc Faber, hat tip reader Megan), the Baltic Dry Index, a proxy for international shipping and international manufacturing, continues an alarming fall. While the BDI is known for false positives about trends in economic activity, the dramatic decline in BDi is partly the result of an inability of shippers to get banks to accept letters of credit from other banks. As we have said before, if this pattern is not reversed, it is Smoot Hawley on steriods.
From Bloomberg:
The Baltic Dry Index, a measure of commodity-shipping rates, fell to the lowest in more than six years in London yesterday as slowing economic growth cuts demand to move coal, iron ore and steel. Commodity shippers will begin to collapse within the next six months and “significant” numbers may fail within two years, according to Fearnley Fonds ASA, a specialized maritime investment bank.
“Demand for commodities is definitely slowing down,” Yu Mengguo, a senior analyst at Jinpeng International Futures Co., said in a phone interview from Beijing today. “That’s being reflected in tumbling prices, which we can’t see the bottom for right now.”
Commodity prices are slumping worldwide on speculation a global economic slowdown will reduce demand. The Reuters/Jefferies CRB Index, which tracks commodity futures prices for 19 raw materials, plunged to the lowest in four years yesterday.
The Baltic Dry Index fell 66 percent in the three months to Sept. 30, the largest quarterly drop since the exchange began compiling the data. The measure of commodity-shipping costs is down 62 percent so far this month at 1,221 points, after rising to a record high of 11,793 points on May 20. It fell for a 13th consecutive day yesterday.
Note that the BDI fell again today, to 1149, which puts it more than 90% below its May peak.
Reader John pointed to this article from Hellenic Shipping News, which reports that shipping companies are barely breaking even and some are keeping vessels idle:
Dry bulk shippers are going the way of the global economy: under water. Among the shippers, DryShips and Excel Maritime Carriers have been hit particularly hard because of their large debtloads and significant spot market exposure. For the 13th straight day, the Baltic Dry Index, which measures dry bulk shipping rates on 40 routes across the world, tumbled Wednesday, falling 71 points to 1,221.
The BDI began its slide over the summer, and it has been taking shipping stocks down with it…
“Day rates have fallen below costs for some ship owners,” Landsberg said. “Rather than take inadequate fixtures, they are anchoring their vessels and letting them sit idle.”
Day rates on Cape-size ships, the largest vessels, tumbled 5.9% on Wednesday to $9,359. Cape-size day rates have plunged 49.1% week-over-week to $18,400.
Landsberg blames the turmoil in the dry bulk shipping sector on two factors: the ailing equity markets and Chinese steel prices, which have tumbled. As Chinese steel producers–who are major importers of coal and iron ore–have cut output to try and boost prices, iron ore imports have declined and shippers have been slammed.
Most observers thought the dry bulk market would worsen in 2009 and 2010 because of the substantial number of new vessels due for delivery, but the downturn in the global economy has brought the good times to a quicker end than anyone expected.
Even the last-ditch scenario of scrapping ships to sell for steel is not an option anymore as buyers of scrap have had difficulty getting letters of credit to do so, Landsberg said. With steel prices lower, ship owners are also less inclined to scrap their ships.
“Everything’s at a standstill,” Landsberg said.
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Maybe this is a good thing. Maybe it’s time for us human to start thinking about our long-term plans, about how we should use the resources that are at our disposal. Do we really need more ipods, xboxes, flat tvs and such?
“A man should examine his life, or it is worth nothing”.
I’ve been following the BDI, its components, and the reported fixtures regularly for a few weeks now.
2 things:
1 ) Contracts just are not being signed. It’s at a standstill and that supports the reports I have seen of choosing to let the boats idle in ports until things pick up
2) The BDI decline has been dramatic, but has recently decelerated. Notably the hardest hit Cape size has slowed its decline, and now the supramax (suez canal) is the biggest decliner. While the index is still falling, it’s been at a constant linear rate.
The decline will not stop until commodities bottom and start to increase. The BDI probably will lag as there won’t be anyone ready to speculate on chartering a boat. We’ll have to wait and see the exporters find a price that they are profitable for them.
The price of the oil is not in the price of contracts reported to the BDI.
As for China, economists are wary of it slowing but the mania at ground level is still quit high. I’ve tracked the supertall skyscrapers in China and they are still being proposed/built/moved-up at the fastest rate ever. There are no large projects on hold.
Sooner or later someone is going to have to capitulate in the China/Brazil iron ore ‘negotiation’. There are virtually no boats in transit, and it will take weeks before regular flow can resume
Shipping lines can’t park their overcapacity in the Mojave like the airlines. Quelle domage.
Anyway, this by itself doesn’t indicate another Smoot-Hawley. When you know you’re in a deflationary period it’s better to deplete inventory than restock. You’ll do better tomorrow. That has to be a great component of the BDI. Then again there’s that business about “just in time”.
And we are talking about commodities. I wonder what container rates are doing? I’ve commented before about the L/C problem being the most inconceivable and scary aspect of a malfunctioning banking industry. If L/C’s are a serious problem it will affect containers equally. And if that’s going off a cliff too… people go hungry.
What I’m saying is that a temporary lapse in orders for commodities where prices are falling may not be serious. But a more general lapse in orders due to “finance” constraints is another question.
Today, at least one bulk carrier ordered its captains to avoid the Suez Canal (and thus the Gulf of Aden) and go around Cape of Good Hope, instead.
The orders are to avoid Somali pirates, but you could think of it as parking your ship in the Mojave, couldn’t you?
evilhenrypaulson – where do you get your info on contract signings? And do you know why they aren’t getting signed?
I agree that as long as commodities are falling things will probably worsen. The effect is a little like investment under deflation – as long as commodity prices plummet, people will try not to own any, which means they will delay purchases. Unlike investment under deflation, there’s a limit in that once stocks run low they *have* to buy. But stocks might have gotten really high for speculative purposes during the commodities bubble so we might have a long way to go. Anybody got info on how much iron ore and such is sitting around? I guess a lot is in China and we’re not going to have good data on that.
I was relatively sanguine about BDI last week because it was still at a relatively “normal” number. Now, adjusting for inflation, it’s approaching the recession level of about 800 in 2001. Still not a disaster, but when it falls 1/3 in a week, it could obviously become a disaster very quickly. Given the overall BDI was down about 5% yesterday, I wouldn’t call it “decelerating” yet.
MarcoPolo,
I am afraid you misconstrued my point, which I discussed at greater length on earlier posts.
If banks are not honoring other banks’ letters of credit, international trade will break down. A seller is not going to ship cargo unless he has assurance of payment. Similarly, a buyer is not going to send a payment for cargo before it has arrived, since the shipper can renege. Various mechanisms in bank letters of credit solve this problem.
Banks appear not to be honoring L/Cs as part of general aversion to taking bank credit risk. It is hard to get any systematic information here, but we keep seeing mention of trouble in arranging for financing, and occasional longer-form discussion.
And trade breaking down IS Smoot-Hawley on steroids.
Other good indicators are:
1)Los Angeles Port container statistics – monthly release.
2)The container index -weekly
3)North American Intermodal carloading – weekly.
I agree that all the new big boats are effecting bulk rates. Also lots of US commodities are now being shipped via container because of increased coal loadings.
I’ll leave to others the pick through the wreckage but the music you hear in the background are the violins for another bubble going splat.
With the mania, among others, that “China is taking everything not tied down” the Baltic went up 12x in less than five years, such that even crude oil blushed. Mind you the entire world knew China had been growing at 8% plus for twenty years. Whatever, the sleepy Baltic awoke from a 30 year trading range and went through the roof. At 90% off its high it probably is fairly priced back inside its long established trading range of 500-2000.
I’m with Gandi. In fact, I like the idea of becoming a pirate. Then taking the cargo containers to the people who were exploited to produce the goods, feeding them and starting a commune with homes built from the empty cargo containers. Ahoy Mates.
faireconomist,
Some random (possibly repeated) info:
Chinese steel mills have been trying to boost their margins by cutting supply/raising price. They’ve been trying to use that window of opportunity to negotiate lower prices with Brazil.
So China had it’s steel mills do some PR today talking about how they will be oversupplied from increased domestic production. That tells me they’re running low on inventory. Regardless of domestic steel prices, they are still approving and completing new mills every day.
China has 5% of the world’s iron ore reserves, and 25% of the world’s steel production. On top of that China’s iron ore is low grade, yielding about half the Iron as high grade deposits which make up most of the world’s proven reserves. They have about 1-2% of the world’s Iron to be refined into steel.
As for
re: L/Cs,
For the time being I think problems with L/C are overblown. I have done some checks and it’s only a minor problem for those who had not secured contracts with a bank in good times. It’s only a worthy story because of what would happen if it were true. The present slowing of shipping is because:
• there were speculators who would resell the shipping contract, and this caused everyone to secure very forward looking contracts. It’s the opposite effect now where people want to see how cheap they can get a deal
• with demand for everything in the process of rapidly dropping, there is no safety margin that you will make a profit on a shipment
• result: ships sit in port with a known loss, and the hope of getting a contract above current prices in the near future
We have now have to wait for some scarcity to re-engage price discovery, and once that has taken hold the shipments will resume their regular volume. Due to the low volume of transactions (both in commodities and BDI fixtures) we can safely surmise this is paper trading only.
We’ll need to wait until next quarter, but ever since JPM acquired Bear Sterns, when they also acquired significant commodities positions, and GS/MS became compromised by the Lehman failure while they had a well known bias long many commodities, there is speculation that JPM has been driving the markets. Even if JPM only played a minor role, this paper trading is simply driven by reversing the earlier in the year successful long commodities/short dollar. Anytime there is such a certain and successful trade there will follow vulnerable margins after.
This price discovery could come at any time. I have heard from a large asset manager that there is some musing about a crush of gold, or other commodity futures holders, demanding delivery — perhaps in December.
On the liner end of things…It's the trade lane managers & line managers of a Maersk, Hapag, NOL, etc. who have the best vantage point. A good point of reference would be the JOC or American Shipper. Bleak times are ahead
as containership charter market is overtonnaged, costs are increasing, and the EU directive abolishing the 100 year+ conference system has come just into force.
On the dry market, it's important to establish how far down the actual loadings on the major routes have been off the past during the past several weeks and access the current level of inquiries. The BDI has fallen from record heights- that doesn't necessarily correlate that trade has collapsed. The economics of shipping are central to the BDI freefall not withstanding the general global recession panic.
DL
capt’n anon @ 9:35:
how about just grabbing the ones sitting in the docks filled with produce rotting as we speak?
shame to waste no?
dig the container architecture idea.
just beware the hollow men:
http://www.youtube.com/watch?v=845Hx3XV9EU
It is admittedly anecdotal, but we have gotten reports of shipments sitting in port due to to banks refusing the buyer’s banks’ L/C. This with well established buyers with rock solid balances sheets and big international bank L/Cs. We have seen repeated reference to this issue in most stories over the last two weeks on the fall in the BDI. The Canadian press has reported that grain is not shipping for the same reasons, and the problem is new to Canada but has affected the US and Mexico for a month plus.
Volumes falling to an unwinding of the China/commodities boom is one thing. But trade finance seizing up is an entirely different matter.
yves smith,
That grain not shipping was because the buyers wanted to get out of the previously contracted higher price from the person I asked (re: Vancouver and Canadian Wheat Pool). I have also confirmed small shippers with a regular history have been unimpeded in these respects.
I have not seen the multiple independently-sourced reports re: L/C that could confirm it. What I have seen is the crafty re-reporting of about 2 original stories. The rest confuse companies coming to a bank for the first time to seek a L/C or insurance, and not being able to get one because banks are cautious about their other lines of credit being drawn on. It is not about one bank refusing the next’s L/C. I think if you look at the articles now, you will not see any sourced report of banks refusing L/Cs — barring the aforementioned one that turned out to be about commodity pricing.
It’s more of a pandemic of lazy journalists as they seek to find a 2 line explanation of why shipping and the BDI is down dramatically.
Logically both the importing and exporting governments would have stepped in to ensure continued trade flow if the L/C was widespread. One of the lowest risk, most valuable products of credit to a country.
What I want to communicate is that while speculative trading may be halted due to the 2 factors of increased speculative grade credit rates, and depreciating goods, that there are no trade financing difficulties for traditional importers/exporters and thus trading continues.
Container traffic is down because demand is down, and dry shipping is down because demand is temporarily down due to commodity paper trades and China’s negotiating tactics. Trade financing has an impact that is invisible compared to these factors.
As for liquids, the market remains soft but there have been 5 VLCCs decommissioned this year so it’s better than what it otherwise would have. The important thing to BDI and shipping’s near future is how many of the previously contracted ship builders actually complete. If most of them complete on schedule then I think we will see the decommissioning of all but the newest ships as I expect a global recession with less trade volume and adding to a record number of ships does not make economic sense as a business.
L/C are definitely something _to monitor_, but nothing has happened yet
For some perspective of how far the credit crisis has or has not reached, see this minnesota fed working paper that highlights some of the recent credit data
Thank you EvilHenryPaulson for sharing your information.
I have been thinking that if L/C is the block, it should be the first thing for the government to do the plumbing as as EvilHenryPaulson say it is vital and yet low cost for them.
So I think current situation is something like 90% fundamental driven and speculation unwinding and 10% L/C problem. Meaning bounce back of BDI index is unlikely until we see commodity prices picking up again. And given the pouring supply of new vessels, maybe BDI recovery will be slower even then…
EvilHenryPaulson,
I have been told by someone I know personally of two separate cases (as in different sets of players in each incident) of shippers with LONG established histories, sound balance sheets, of having their banks’ L/C refused by the shippers’ bank. Banks in question were both large international banks.
I would not cast aspersions on journalists if you have not read the stories in question.
Thisarticle from the Financial Post has specific quotes that point to L/Cs being an issue. For instance:
Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don’t trust the financial institution named in the buyer’s letter of credit, analysts said.
“There’s all kinds of stuff stacked up on docks right now that can’t be shipped because people can’t get letters of credit,” said Bill Gary, president of Commodity Information Systems in Oklahoma City. “The problem is not demand, and it’s not supply because we have plenty of supply. It’s finding anyone who can come up with the credit to buy.”
So far the problem is mostly being felt in U. S. and South American ports, but observers say it is only a matter of time before it hits Canada.
“We’ve got a nightmare in front of us and a lot of people are concerned it’s going to get a lot worse,” said Anthony Temple, a grain marketing expert based in Vancouver.
Note that the Canada article describes it as a PROSPECTIVE problem there, not one that is happening now. If it was the deal-breaking as you suggest, it would be reported as a current issue.
The article also suggests that there is a separate issue with buyers being slow to pay.
People do not decide to become involved in international trade overnight, particularly in this sort of environment, so I find it hard to believe that the issue is that of new buyers.
And intuitively, this makes sense. If banks will not lend to each other (much) in the interbank market, the L/C market often has longer exposures (some L/Cs are financial L/Cs, the others are documentary, which require that the shipper satisfy certain paperwork requirements to establish that his goods are what he says they are, that he has paid applicable duties and taxes, etc.), I would imagine that the length of these commitments is somewhat uncertain (that unlike interbank lending, which has a date certain for payment, which would also make them less attractive in an environment of extreme risk aversion.
I find it quite plausible that this issue is not on the radar screen. Does the shipping industry have any lobbyists in DC?
The L/C business is a complete backwater in banks. Low margin, operationally intensive. It is not a career path into senior management. It is very plausible to me, based on my experience consulting to banks, that a seize up here would go unnoticed given all the other pressing problems. This is just not a priority area for them from a business standpoint. Similarly, regulators pay it no mind, so again, Treasury, the Fed, the ECB would not even think about this until the pain became acute.
> Does the shipping industry have any lobbyists in DC?
Every industry has lobbyists in DC, including the arrowhead industry.
What if, through banks, with the up coming currency summit (Brent II, whatever) a message is being sent to play ball with the US or look what happens (shipping). A type of warfare or at the least a chess match maybe a game of chicken. Can Iran survive without wheat shipments, China without raw materials, Russia without a viable currency? Diabolical thinking, isn’t it?
no matter whether the reason is fear, greed, willfill ignorance or diabolical gamemanship (or any combo), any system that gives humans a temptation to allow food to rot idly while so many people on this planet continue to starve needs to disappear into the vortex and be replaced by a system that at least addresses the fundamental cracks in the system.
beginning to think that there may be a silver lining in this tsunami.
Prepare for the worst. Hope for the best.
Yves, with reference to your reply of October 23, 2008 8:54 PM. Which is now so long ago I hope you see this.
I apologize for not having been clear. Actually, I don’t think I did misconstrue your point and I saw the earlier post too as well as the Financial Post article.
“If banks are not honoring other banks’ letters of credit, international trade will break down.” GIVEN.
“And trade breaking down IS Smoot-Hawley on steroids.” GIVEN ALSO.
“Banks appear not to be honoring L/Cs as part of general aversion to taking bank credit risk.” NOT SO FAST. I WANT TO QUIBBLE.
As I tried to explain earlier, a L/C is a bank guarantee. No bank will make that guarantee without having a guarantee of its own. And an iron-clad one at that. Unlike the derivatives business, there is lots of history here in what you call this banking backwater. This is not something that hasn’t been thought through. There really isn’t any credit risk in an L/C. There is only “counterparty” risk. That’s why you can buy a L/C for a $50 fee. If it is in fact true that shippers are having difficulty obtaining L/C’s it’s because of the “counterparty risk”. And in today’s environment that risk may not be well known. Which is to me even more disturbing than if it were credit risk. Credit risk being the easier to price. If counterparty risk is such that shippers cannot get L/C’s – no deals. No exceptions. All stop. Mothball ships. You say Smoot-Hawley. You would be right to be alarmed.
I only meant to suggest that problems with L/C’s are not a driving factor in the drop of BDI. I myself suspect that BDI would be more heavily influenced by the fall in commodities prices than problems in obtaining L/C’s. Difficulties in obtaining L/C’s would also be seen in places other than BDI such as container rates. Container rates themselves are heavily influenced by general levels of business activity, which is sure to slow, and also foreign exchange rates. Bottom line is that it would be very hard to separate out the effect of L/C problems in these published numbers. I’m guessing it’s a minimal problem at the moment in spite of the story of the grain at the Vancouver docks. I bet it has to do with price and that some weasel wants out of his contract. Or that he made his contract and now can’t make his own guarantee with his bank. In the absence of his guarantee his banks L/C (guarantee) will not be forthcoming. I suspect that there are lots of goods on order that can no longer be paid for.
Love your work.
One for your side, Yves.
I just saw this in The Economist after writing to you and it corroborates your post on BDI.
Oct 18 issue pg. 71. Industry and the financial crisis. You can find a web link.
“There is even talk of grain cargoes piling up in ports in the Americas. [No doubt the same Financial Post report that we’ve seen.] Their buyers’ letters of credit have not been honoured, because of a lack of confidence in the banks that underwrite them. At least one Australian producer has had the same problem with iron-ore shipments.”
The article then goes on to describe the fall in BDI and discusses falling demand for commodities. Though that specific mention does corroborate your point, the writer drops the ball if L/C problems were to be a significant factor in the level of ocean traffic. It’s the only place that it’s mentioned. And the consequences of it being a serious problem are not mentioned at all. Given that the fall in BDI and commodities prices are already well known to anybody paying attention, if it were important it is somewhat a surprise that the writer neglected to dig deeper into the L/C question.
I still contend that isolated incidents (and so far they appear to be isolated) of L/C difficulties represent buyers’ desire to renegotiate contracts or their own inability to comply with previous commitments.
Thanks for the link to Clusterstock.