The Baltic Dry Index isn't a regular best stock index like the S&P 500 or the NASDAQ. It's actually a composite survey of daily shipping prices around the world. And although it doesn't track underlying stocks market indices, its movement does affect almost every shipping company's share price, as it is viewed as a proxy for the overall industry. As the index has plummeted, it has taken the share prices of most shipping companies with it. This provides new investors a chance to capture some of the most appealing yields that we have ever seen.
The BDI's Bubble Trouble
In May 2008, the Baltic Dry Index was riding high. Commodity prices were still on the upswing, and commodity buyers were insensitive to shipping costs. In preparations for the headaches of tighter port security surrounding the Olympics, Chinese companies had stockpiled raw materials, pushing shipping prices even higher. And the U.S. subprime crisis appeared to be contained at its borders ― meaning the rest of the world's trade went on unhampered. On May 20, shipping spot prices hit an all-time high.
No one, not even the shipping companies, considered the May highs sustainable. But few anticipated the perfect storm of downward pressure shipping prices would face over the next few months. How bad has it been? Rates for Capesize ships ― so named because initially their large size prevented them from using the Suez Canal, forcing them to sail around either Cape Horn or the Cape of Good Hope ― that were priced at $230,000 a day in late May have fallen to almost $20,000 a day. The Panamax-class shipping rates have seen a similar trend, tumbling from daily rate quotes of $90,000 a day to about $12,800.
The BDI has fallen more than 90% since its high on May 20, 2008.
There are a number of valid reasons why the Baltic Dry Index should be off its highs. In addition to being grossly overheated just a few months ago, the U.S. subprime mortgage problem blossomed into a full-blown financial crisis and has undoubtedly weighed on economies outside the U.S. When world economies slow down, the demand for shipping also slows. And the speculative bubble in the commodities market also has burst, making commodities buyers more price-sensitive when it comes to shipping.
Short-Term Problems, Near-Term Solutions
Many of the short-term pressures weighing on shipping prices are already showing signs of abating:
* Easing Credit Worries: The worldwide credit crisis that has made it harder for small companies and consumers to borrow money, has also made it harder for dry bulk buyers to get their cargos loaded onto ships. Now, the credit freeze has begun to thaw. Bank-to-bank lending has resumed. Governments around the globe have put up hundreds of billions of dollars to back the world's banking system, and letters of credit appear to be navigating their way through the system again.
* Stabilizing Demand: In an effort to reduce pollution, China shut down hundreds of construction sites, coal-fired power plants, cement factories and chemical manufacturers a month before the Olympics and throughout the games. While this was only a temporary measure, the drop-off in shipping demand made an already nervous sector panic. But the temporary fits and starts from the Beijing Olympics are now long behind us. The Olympic cutbacks were not a real measure of demand any more than the pre-Olympic build up was, and these anomalies are now being seen for what they were.
* Short-Term Feuds and Still-Strong Growth: A tiff between China's steel companies and Brazilian iron ore suppliers, which has resulted in limited shipments of ore between the two countries, had wreaked havoc on the index. This situation has cooled, with Brazilians backing down from the price hikes they were demanding. Bottom line: China will need iron ore and other materials to build out that growth. Brazil and other international suppliers with sell it, then ships will move it.
Generous Yields at Unprecedented Highs
As many of the temporary pressures on the Baltic Dry Index are already starting to ease, it's hard not to believe the BDI has overshot its floor and will soon find a more rational level ― certainly off its unsustainable highs but also above its equally unrealistic lows.
In fact, we're already seeing this. The BDI is more than +20% off its lows ― but still nowhere near a rational level. And as normalcy returns to the index, investors still have a chance to profit from shipping's worst fears. While you can't trade the index itself, almost every shipping stock was pummeled by the fall, and most will follow it up on the rebound.
In the meantime, with many shipping top stocks trading near their 52-week lows, already generous yields are at unprecedented highs. Investors not only have the opportunity to lock in 10%-plus yields with hot stocks like Navios Maritime (NYSE: NM), they have the added potential for share price gains once sanity returns to this sector.
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