It's the stealth rally no one's talking about ... well, except for me in Real Money. Ha! Hubris aside, I cannot help but note that the Baltic Dry Index (BDI) rose again Thursday, with the headline index at 405. As I mentioned in these columns, I believed the BDI's plunge to a level of 290 on Feb. 11, the lowest reading in the measure's 31-year history, was not sustainable. Ships were trading at daily rates that were well below their daily operating costs. The BDI just could not have stayed at those levels without wiping out millions of tons of steel value.
As I mentioned in Thursday's column, that date was the recent bottom for the S&P 500, and not coincidentally marked the bottom for the freight index.
While the BDI measures the average of each day's fixing prices for the four main dry bulk ship classes (Capesize, Panamax, Supramax, Handysize) in the physical market, there are also freight derivatives, known as forward freight agreements (FFAs), that trade based on the underlying BDI index values.
So, if we go back to February, every loafer-wearing, jargon-repeating hedge fundie from Stamford to Cos Cob was predicting that China was going to exit the face of the Earth, which would bring us $20 oil and destroy the major end user of the commodities -- coal, iron ore grains -- shipped via dry bulk ships. They acted on those predictions by shorting the futures contracts underlying the commodities.
They had a good run in the first six weeks of 2016, but, man, have they been taking it in the shorts for the past six weeks. And that's what's really happened to shipping rates, oil futures and so many other commodities and commodity derivatives ... and what spurred the bounce-back in the S&P 500. "Paper" short trades have been covered and commodity derivative prices have been allowed to rise to levels that more accurately reflect the economic cost to produce them.
Supporting data for my "removal of shorting hedgies" theory comes from Bloomberg (quoting eVestment) and its report Wednesday that hedge fund flows dropped 80% in February. Ouch! February is typically a month of inflows for hedge funds, but last month's paltry $4.4 billion inflow paled in comparison to the $22.6 billion average for February 2010-15.
So, with speculative pressure removed, the freight rates could return to normal levels ... but we're not there yet. At Wednesday's cash fixing levels, Capesize rates ($2,005 per day) are well below daily operating expenses, and Panamax rates ($3,673/day) are as well, by my figuring, with the smaller Supramax boats ($4,897/day) just getting near a break-even daily level.
So, as I mentioned in my first 2016 column on dry bulk, it continues to make no sense that a Capesize -- which can hold 180,000 deadweight tons -- would trade at a 60% discount to a Supramax that holds about 60% less cargo.
It's a dislocated market, and until it returns to normal I'm looking to get into the dry bulk space for a mean reversion trade.
The Series G preferreds of Navios Maritime Holdings (NM-G) have performed well since I named them my Real Money top pick, and it's nice to be on the leaderboard with some of the great RM stock pickers.
In addition, I have been adding to my exposure to shipping this week with another fixed-income name. I've been buying Scorpio Bulkers' exchange-traded 2019 7.5% Senior Notes (SLTB) for my clients' portfolios. Scorpio is more leveraged to a dry-bulk recovery than even industry titan Navios is, and Scorpio management has made all the right moves -- selling old ships, canceling and delaying several new builds and even raising $63 million in a common equity offering that priced March 17.
I love to be senior in the capital structure (notes vs. preferreds) and I love the fact that Scorpio has been taking all the necessary steps to increase liquidity and thereby improve creditworthiness of the SLTB notes, which currently yield 12.5%.