URSABLOG: Leading Indicators?

It’s one of the hardest things to get our heads around: there is no correlation between freight rates and commodity prices, whether positive or inverted. Despite the efforts of many to prove me wrong I remain stubbornly unconvinced. Commodity prices are very important to world trade I know, but we are not moving prices around in ships, we are moving volumes of cargo over distance. This is evidently something different.

Many people – who perhaps should know better – fall into the trap of freight rates being lead indicators of something, whether it is economic growth, inflation, commodity prices themselves but they can’t seem to accept that one doesn’t slavishly follow the other.  Thankfully this usually happens when freight rates are at their highest, i.e. when the financial markets have noticed that there is a lot of money being made in a market they haven’t got their grubby little fingers on yet, and when they do it is usually just about the time when the markets are about to crash anyway, so no worries, it will be too late for them to do too much damage.

As far as freight markets being a lead indicator of something, let’s break it down into the three points I mentioned earlier: economic growth, inflation and commodity prices.

Economic Growth

It makes sense doesn’t it? Rising freight rates are an indicator of increased demand for stuff, whether raw materials or semi-finished or finished goods, right? Wrong. Because freight rates are based on the demand for cargo over distance, and depend on the balance of supply of and demand for ships of certain types and sizes, if there are fewer ships in the water, comparatively speaking, freight rates can be high when demand is falling. But when there is an over supply of ships, the freight markets can be terrible even when demand for cargo is high. Add in a few novel features of our own era, for example the Red Sea proving unwelcome to ships transiting one way or the other, especially those that have been legally trading (or are legally owned) in places that are not to the Houthi’s (or their political masters’) tastes, then ships taking the longer and safer route around the Cape of Good Hope decreases the supply of available ships, and therefore increases, if somewhat momentarily, freight rates. Likewise ships that are taken in what are known as the ‘dark trades’ (better you do not ask too much) are no longer available for trade in the open freight market, therefore reducing supply with similar results. And as Russian cargoes become less attractive to markets closer to Russia, they have to look for buyers further afield, even if the trade itself is non-sanctioned – oil to India for example, even coal to South Africa. The ships undertake longer voyages, and are therefore not available for earlier employment. Net result? High freight rates.

So higher freight rates do not necessarily indicate the promise of economic growth, they just reflect the supply and demand balance in the fleet reacting to a particular set of economic and geopolitical factors, which could unwind fairly quickly, leaving shipowners facing lower freight rates.

I do accept that increased trade, which can drive increased economic growth can increase the demand for ships in turn, but this is something different, and a far harder pattern to track, let alone forecast.

Inflation

The cost of shipping, even when freight rates are at their highest, is negligible compared to the final delivered overall cost of the cargo. The proportion of freight rates to the delivered cost of the cargo is highest in the cheapest dry commodities, and lowest in consumer goods. Even with oil prices lower, this remains the case: if the current price of Brent crude is around US$ 75 a barrel (a disastrously low price to some) then the value of a VLCC cargo is around US$ 150 mill, well over the newbuilding contract price. Let’s assume the timecharter equivalent of such a ship is US$ 40,000 day and a round trip from AG to China is 100 days, then the freight for the voyage is around US$ 4 million, a miniscule 2.6% of the total value of the cargo. Doubling the freight rates doesn’t move the dial much, unless you are a happy VLCC owner. Likewise halving them won’t do much to stimulate demand. It affects inflation even less.

I was told that at the height of the COVID induced container boom, freight rates increased the price of a pair of US$ 100 Nike shoes by the exorbitant amount of 90 cents. So those that think increased freight rates increase inflation haven’t looked at the real costs of shipping.

That is not to say of course that a demand for increased goods from consumer economies might increase demand for ships, and that may show up in freight rates, and this high consumer demand may be accompanied by increasing inflation, but again these are different things and one does not always lead to the other. It might show in one phase of the cycle, but is over almost before it has begun as shipping readjusts to the new conditions, and, as I hope I have illustrated, the costs for shipping themselves do not affect inflation.

Commodity Prices

Let my start by first saying that the relationship between freight rates and commodity prices is complicated, and changes continually. Low commodity prices may stimulate demand, increasing the demand for seaborne cargo and therefore ships, and increasing freight rates. Likewise high commodity prices may dampen demand, and therefore demand for shipping. Equally however, a restricted supply of a commodity with constant demand will lead to a higher commodity price, but obviously won’t increase the volumes of cargoes shipped, rather the reverse, and freight rates will fall. Oversupply of commodities will reduce the price of the commodity, but it will not help if demand is tepid and no-one is buying increased amounts; freight rates will not recover just because a lot of cargo exists.

But then of course things change, whether caused or affected by commodity price movements, changes in economic and political activity or whatever; the interaction between them is not pre-ordained as the last few years have shown us.

Many of us are trying to get an angle on expected freight rates as we enter the final quarter of 2024. For dry and wet markets, the story (again I am not entirely convinced) is usually for a fourth quarter revival, but sadly I don’t think we can look to commodity prices as a guide. I am indebted to Rob Amstrong and Aidan Reiter of the Unhedged newsletter of the Financial Times for providing me with continual inspiration (as well as the graph and the comments below).

The prices of oil, iron ore and copper are falling this year:

An explanation of the simultaneous decline is that global demand is soft, in particular from China. Panmure Liberum’s Tom Price comments on iron ore:

After years of price-buoying disruptions [the] mining-majors are finally delivering an unmitigated, record-high, collective flow of ore to their principal customer, China. Problem is, China’s need for ore — and the steel generated from it — is faltering. What’s happening over there? Growth in China’s property sector, which takes about 40 per cent of its total steel supply, is collapsing. Already down 30-40 per cent year to date, is there any upside for ore prices? Not yet.

Has this markedly affected capesize rates yet? Not really. Are prices for secondhand capesizes crashing in anticipation? Not that I can see.

Oil is down. Kieran Tompkins at Capital Economics also thinks China’s slowdown is the main reason:

Looking at China’s own oil production and their net imports of oil products, it’s clear that China’s oil demand has peaked.

It is arguably true that the tanker freight market is showing signs of softening, but the boom is by no means over.

As for copper, the main demand catalyst – the green energy transition – is taking longer to arrive than expected.

“The copper rally is delayed,” Goldman Sachs analysts said rather diplomatically, as they undiplomatically cut their 2025 price forecast for the metal by a third this week.

Now copper and copper concentrates do not amount to much in tonne-mile demand for dry bulk carriers, but the pricing of good old Doctor Copper is seen as a major barometer of global economic growth. Freight rate movements of geared ships – either as a lead indicator or as a result of increased commodity movements – is little help to us here.

But there is a silver lining. As Armstrong and Reiter point out:

It would be good if global growth were higher, and it would be good if the green transition were transitioning more quickly. But there is an upside here. Falling commodity prices make it less likely that, as the Fed eases policy, inflation will reignite.

Falling interest rates are a good thing, but will they by themselves ignite demand for commodities over time and space? It is – obviously – hard to say. There are too many in between things – fleet supply, geopolitics, commodity supply – for there to be a possibility for a direct causal relationship.

So I remain unconvinced that there is a story here that can guide us on what will happen to the freight market looking at the slight shifts in economic growth from the biggest markets, falling inflation or falling commodity prices. Likewise I don’t think anyone from outside – or even inside – shipping can take anything from freight market movements in predicting economic growth. In any case, what is happening? Not much. The dry market is flat, boringly, numbingly so, as it has been for most of the year. The tanker market is softening, but has the ability to – still – surprise on the upside. And containers are falling, but only after a fresh geopolitical boost that increased tonne-mile demand to provide temporary refuge from the coming deluge of newbuilding deliveries.

And for my market, the ship sale and purchase market, what does this mean? Am I a buyer or a seller? Neither. Both. It’s complicated. It depends, and not only on what my clients want and need to do, or what I think about, and what solutions I can provide, but events too. In the meantime, beware the siren songs of easy explanations and nice graphs, especially those showing telling correlations: shipping retains it’s attractiveness because of the risk of the unknown, not in spite of it. No wonder those outside it can never get their heads around it.

Simon Ward