With Hindsight: "Sell in May and Go Away"
In the equity markets, it is often suggested that one should “sell in May and go away”. While it is not necessarily a foolproof trading strategy, the perhaps somewhat dubious rationale is that lower liquidity and lack of significant news flow during the summer make trading dull and without much opportunity for profits. However, this year has provided equity investors with ample amounts of volatility and short-term profit opportunities since May. Still, it has not been the ideal environment for anyone looking for a restful summer and plenty of quality sleep.
On reflection and with the great benefit of hindsight, the approach would nevertheless have been a suitable strategy for anyone involved in the dry bulk Capesize market, especially when it comes to holding long positions. Freight rates for the largest vessels, not counting the VLOCs, have endured a brutal summer so far amid low demand in the face of holidays in the Northern Hemisphere and rising economic headwinds globally. As of Friday, the Baltic Exchange’s Capesize Index had lost 69 per cent of its value since its peak for the year on the 23rd of May. While there have been periods during the last two months when the index has risen, they have been brief with positive momentum short-lived.
In general, the dry bulk freight markets have faced extensive headwinds in recent weeks, and the Baltic Exchange’s dry bulk indices have all been in the red for nine consecutive days. However, the negative performance for the mid and small-sized tonnage segments pales in comparison with their larger siblings. During the period since the year’s high for the Capesizes, the broader Baltic Dry Index has declined by 54 per cent, reflecting a somewhat less painful journey for the mid and small-sized vessels. The gauges for the lesser tonnage segments have seen losses of around forty per cent since late May.
Global cargo order volumes for the Capesize segment have been trending lower since the brief peak after the Chinese New Year. Although, the process accelerated towards the end of May, as China’s Zero-Covid policy continued to disrupt demand for many commodities and the risks of a global economic slowdown increased. The negative momentum for the order data has continued to build during the summer as sentiments become increasingly downbeat. However, if history provides any guidance, the recent weeks show an emerging seasonal pattern that could indicate improving order volumes in the near term.
Like cargo orders, the global supply of Capesizes has been tending lower in recent months and reached the week before last levels typically seen around Christmas. Under normal circumstances, lower tonnage supply should provide support for freight rates, but the drop in demand has more than offset any such effects.
The limited flexibility of the largest vessels has been one of the main culprits for the segment's relative underperformance. The vessel type has, like iron ore, become increasingly tied in with the fortunes of the Chinese economy. With the country likely to miss its annual economic growth target for the first time ever this year, there are clearly some warning signals for the segment ahead. However, the importance of social stability for President Xi’s reelection as the country’s leader is likely to keep the stimulus programmes well funded and provide support for the country's appetite for dry bulk commodities in the near term.
Following a seasonal recovery in July for Chinese coal cargo orders for Capesizes, August has also started on a positive note. With only a few days of the month behind us, order volumes have already surpassed what was recorded for the whole of June. While it is early days, if one was to assume a high degree of linearity in ordering activities, volumes for August could match the dizzy heights observed in September last year. The strong start for August suggests that Chinese imports of coal will increase in the coming months, given the forward-looking nature of Shipfix’s order data.
Demand for Capesizes usually picks up as the year progresses into the second half, following a bit of a quiet period during the summer in the Northern Hemisphere. Restocking activities for coal ahead of the colder weather and the resumption of many construction projects usually boost iron ore demand as steel production increases. While the increasingly depressing outlook for the global economy, amid high inflation and rising interest rates, could put a dent in the seasonal recovery, the aforementioned stimulus programmes in China are likely to alleviate some of the pain. However, the lower-than-expected Brazilian iron ore output goal will provide some headwinds for the Capesize tonnage demand, as the long-haul route from Brazil to China is efficient in tying up large tonnage for long periods and reducing available supply.
In addition, the global squeeze on energy supplies is also unlikely to abate any time soon. If anything, it looks set to deepen. Global thermal coal demand has been projected to enter a process of terminal decline for some years. However, with global supplies of oil and gas inadequate, the dirtiest of fossil fuels has been granted a new lease on life and demand for seaborne transportation of it will remain high. The current extensive price difference for natural gas between Asia and Europe is likely to see an increasing number of LNG cargoes destined for the former being redirected to the latter. At the moment, the price differential is so significant that it might be profitable for traders to break their contracts with Asian buyers, pay the damages, and deliver to Europe instead. Hence, Asian buyers may be forced to import more thermal coal to avoid energy shortages during the coming winter. Still, the seaborne LNG imports will not cover European needs in the face of restrictions on Russian exports, and the continent will continue to rely on imported coal for parts of its energy generation.
Capesize freight rates are likely to enjoy a seasonal recovery as we move further into the third quarter of the year, even if the global economic outlook does not look that rosy. The segment will also benefit from limited deliveries of new tonnage, as the shipowners were more prudent than usual with their cash during the last two years’ robust markets. Hence, without any sudden inflows of new tonnage that will put pressure on freight rates, the market will be driven by changes in demand for the foreseeable future.
