Dry Bulk

The next wave

Edward Finley-Richardson considers how to play a possible bounce in dry bulk freight rates

CNBC host Jim Cramer ends his daily show – Mad Money – with a signature saying: “There’s always a bull market somewhere”.

One of the unique pleasures of being a shipping investor, especially since February 2020, has been to figure out how to deploy capital in an environment in which there always seems to be one shipping sector in a raging bull market. But it’s not as easy as it might seem from studying the stock charts in retrospect: the enthusiasm which coincides with the apex of a rising trend is also usually the sign that it’s time to start deploying money elsewhere.

The past few months have been a humbling experience for many shipping investors. Just as dry bulk stocks seemed invincible, daily freight rates halved in a matter of months. Many of the most vocal bulls among analysts, shipping executives, and shipping investors failed to foresee the dip at all. Typically, those least experienced have been left holding the bag, with stocks 30-50% lower.

A different trend has taken shape in the oil tanker segment: after mild corrections in June — probably the result of a broader sell-off in oil and energy-related names — the vast majority have regained momentum and made new 52 week highs.

The Russian invasion of Ukraine has had an outsized impact on vessel classes which transport Russian crude, such as aframaxes and suezmaxes. But the real bull market has emerged in the clean petroleum product transport, as voyage distances have lengthened to take advantage of crack spread differentials, which have varied wildly in different geographies. Companies which just six months ago had liquidity concerns, such as Scorpio Tankers, have made progress in shoring up their balance sheets, and are even inferring that shareholder returns may be on the table, if rates continue at these levels.

But while tankers have seen analysts, one after another, hail a continued rates bonanza leading into Q4 and Q1, usually the strongest quarters of the year, some astute observers have been eyeing the dry bulk sector, with a view to getting back in. The supply-side picture remains historically strong, as shipowners have by and large remained disciplined and chosen to repair balance sheets instead of ordering more vessels. This means that although the demand side has taken a hit due to Chinese economic woes, the dry bulk party seems destined to resume when demand fundamentals improve.

What is especially intriguing about the current dry bulk set-up is that freight rates – in particular capesize – seem like they could be close to bottoming. They certainly can’t get much lower, as they are already unprofitable for most owners. The $BDRY ETF, composed of a ‘special sauce’ of dry bulk forward freight agreement derivatives, has risen from $4 to $42, and now back just below $9.

Some investors have noticed that while dry FFAs, often considered a bellwether for future freight rates, have plummeted, the stocks have remained comparatively resilient. As access to dry bulk derivatives is limited, the BDRY ETF is the only way for most investors to speculate on the probability that rates will rise from here.

The stocks, on the other hand, are at levels which do not offer sufficient margin of safety. They “should have” fallen further considering the weakness in freight rates, and the uncertainty regarding China’s economy, which is a red flag for commodities demand. The divergence between dry derivatives and the stocks does not usually last long. Therefore I suggest investors consider going long the BDRY ETF; if you are looking for downside protection, you can buy puts on some of the most liquid dry bulk names. ●