Baltic Dry: "Freight Futures Are Set to Rise"

From Barron's Commodities Corner column:

The recent slump in freight costs looks temporary; surging demand for raw materials, especially from China, is set to oustrip freight capacity.
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Get ready for a gust of wind—freight futures look ready to set sail. The recently becalmed dry-bulk sector is likely to get a lift from surging demand for raw materials, particularly from China, which is expected to outpace freight capacity over the next two years.

The Baltic Dry Index, which measures the cost to move freight such as coal, iron ore, and grain across the world's oceans, plunged over the past few weeks, sinking more than 50% from its Dec. 12 peak. Still, at 1106, the index is more than 300 points above its lows from last year.
However, the recent slump in freight costs is only temporary, says Omar Nokta, a maritime analyst at Global Hunter Securities, in a recent research report. Specifically, "heavy storm conditions" slowed the movement of coal and iron ore in Australia and South America, thus reducing the demand for dry-bulk ships, Nokta says. On top of that, slowing industrial activity in China, exacerbated by the Lunar New Year celebrations, weighed on the dry-bulk sector, he says.

SHIPMENTS OF RAW MATERIALS from Australia and South America to China are in many ways the lifeblood of the dry-bulk sector. Iron ore and coal are combined to make steel, much of which is used to fuel China's massive infrastructure-building programs. "With New Year celebrations winding down by mid-February, we expect charter rates across the various dry-bulk segments to rise," Nokta says.

Chinese demand for coal and iron ore should lift demand for dry-bulk vessels by 4.5% this year and 5.4% in 2015, according to projections from Clarkson Capital Markets in a recent research report. That growth should easily outstrip the rate of construction of new ships, which Clarkson projects will increase some 4.3% in 2014 and 2.8% in 2015.

For that reason, rates to charter vessels will also jump, predicts Urs Dur, a Clarkson maritime analyst in New York.

Dur forecasts that the going rate to charter a Capesize vessel, the largest class of dry-bulk carriers, will nearly triple to $24,301 a day in 2015 from recent rates of around $8,400. The Panamax, Supramax, and Handysize classes of vessels will see rallies of at least 65%, Dur says, although the index will be volatile.
That translates into a Baltic Dry Index of more than 2100, according to Barron's calculations, close to double where it is today.

What could torpedo the Baltic Dry Index is a slowdown in the Chinese economy, or a ramping up of the country's domestic production of coal or iron ore. Both scenarios are only really likely if a global recession sets in. In January, China's imports rose 10% from last year, according to official customs data, suggesting continuing strong demand for raw materials.

Investors can profit from the projected moves in the Baltic Dry Index by speculating in forward-freight agreements, which are similar to commodity futures contracts. Alternatively, there's Guggenheim Shipping's exchange-traded fund (SEA), which tracks a basket of shipping stocks. Investors should be aware, however, that because the Guggenheim ETF is more diversified than just companies in the dry-bulk sector, it doesn't always exactly track the Baltic Dry Index.