Chinese Iron Ore Purchases No Longer the Only Driver to the BDI
November 24, 2009
by
In the two months since I discussed the Baltic Dry Index (BDI), the index has rebounded strongly including having set new 12 month highs in the past week. Through much of 2009, the story of the Baltic Dry Index has been one of Chinese iron ore purchases. Recently, in a positive sign for the real economy, other factors are starting to play a role. As we will see below these Chinese purchases have not abated and remain a key factor. To that factor, though, we can add two more.
One big question on investors mines recently is how much of the market activity reflects true improvements in the real economy and how much is simply a result of cheap money flowing around the globe creating asset bubbles. Unlike indices that track asset markets of equities and real estate or recently popularized asset markets of oil and gold, the Baltic Dry Index reflects activity in the real economy. The index tracks rates for dry goods shipped in bulk around the globe. For a detailed explanation of the index please see my article from September.
Baltic Dry Index has reversed its slide and is now hitting new one year highs. This Baltic Dry is actually quite volatile. Its inherent volatility comes from the fact that above a certain point cargo vessels can not always be quickly pressed into service as shipping volumes increase. New vessels are ordered multiple years in advance. A shortage of just a few ships on an important trade route like that between Australia and China can quickly drive up rates.
The period from June through September showed that price gains are every bit as short lived as in the fickle stock markets. The answer to the question of whether a rise in the BDI is a good indicator of economic health is rooted in what is driving the move. Thankfully this can be gleaned by looking at the components of the Baltic Dry.
The Capesize Index has had the most influence on the overall BDI. Of the four lower level indices used to calculate the overall Baltic Dry, the Capesize Index has had the most pronounced movements for the year. Capesize is the largest category of vessel and used primarily to transport iron ore. Swift rises in Capesize index earlier in the year were driven by Chinese stockpiling of iron ore, the raw input to steel production.
Such a move for the Capesize index once again indicates increased activity in the shipment of iron ore. Since the end of Chinese stockpiling efforts was declared by BHP Billiton’s (BHP) management back in their August earnings call, the destination of these ships might not be obvious.
Some of the most important shipping routes are between Port Hedland in Western Australia and destinations throughout Asia. Port Hedland is the primary launching point for BHP’s iron ore mined in the Pilbara region of Australia.
In its last fiscal year, Port Hedland was the origination point for 154 million tons of iron ore, roughly 50% of all such Australian exports. The shipments of iron ore from this port alone represent nearly 1.5% of Australian GDP. The fact that this port is 11% busier than last year goes a long way in explaining why the global downturn had only a minor impact on Australia.
Factor #1 – Chinese stockpiling continues. The Port Hedland Port Authority provides detailed data on its operations monthly. Of the 14.9 million tons of materials shipped last month, two-thirds (67.5%) of it was iron ore headed for China. Of the 107 ships that left from that port last month, 87 of them were carrying iron ore bound for China. Such shipments are running 42% ahead of 2008 levels.
We know that stockpiling is going for the simple reason that, while iron ore imports to China are up strongly, this has translated into only modest increases in steel output. Steel production is only running 8% to 12% of 2008 levels depending on the type. This is impressive for sure when compared with the output from Asian countries but it in no ways accounts for increased imports of iron ore.
Stockpiling can come in two different forms. The most obvious is China’s outright purchase of iron ore that is set aside in holding facilities for use at a future date.
The second is the shut-in of domestic production. Iron ore and coal production in China is considerably more expensive than that carried out by the global mining giants BHP, Rio Tinto (RTP) and Vale (VALE).
By purchasing mostly from abroad and mothballing domestic sites, China is saving the domestically mined commodities for some future date when global commodities prices are higher. China is effectively trading in its American dollars for hard assets – not a bad use of its reserves.
It is likely that the shift that occurred at the end of the summer was to go from the first more overt type of stockpiling to the second more subtle.
A more detailed look at the split of iron ore shipments to China and other destinations out of Port Hedland reveals a continued healthy appetite for this raw material. Shipments to China have come off from their peak from May to July but remain at very elevated levels compared to last year. In the year 2008 shipments averaged a little over 6 million tons per month. Even at the peak of global growth last year, China’s shipments from this key port never amounted to 8 million tons monthly. For all of 2009 they have never been below that 8 million ton/month level.
One difference is that new iron ore supplier Fortescue Metals (FSUMF.PK) began shipments through this port in 2008 and is now running at full volume. Their shipments go all to one place: China.
Factor #2 – Iron ore shipments to other Asian countries are returning. So far this year shipments to other destinations like South Korea and Japan this year have been running 30% below their 2008 levels. This drop is in line with the decrease seen in industrial production. China filled the gap left by other countries for the first half of this year. Since August shipments to Japan and South Korea are returning – on top of a demand from China that subsided only slightly. This results in a steady increase in cargo each month requiring more ships which in turn drives up shipping rates.
There is no way to tell if and when the Chinese demand corrects back to levels in line with its industrial output. The large miners BHP, Rio, and Vale play a large role in determining the price. Hopefully this year has taught them that raising the price too high (as they did in 2008) brings more domestic raw materials to the Chinese market. Keeping the price steady leaves them all in a good position.
Factor #3 – Broader measures of shipping rates are climbing. Unlike the middle of the year, the indices for the small vessel types Supramax and Handysize have started to climb substantially. Ships from each of these categories are used to transport grain and other foods as well as industrial materials such as scrap iron, concrete, and steel.
Increases in shipment rates do not mean that the global consumer (particularly in the West) is back to his old habits. However, it does mean that demand to ship goods is returning slowly. This is a good leading indicator that the real economy is healing.
Unlike when we looked at the Baltic Dry Index two months ago, there are multiple factors driving the increase. Chinese stockpiling of iron ore and other raw materials is a gift for the mining industry but it is artificial and could correct at any time. The other two factors: non-Chinese demand for iron ore and rebounds in shipping rates for small vessels indicate that global trade is starting to rebound.
There is no denying that much of this rebound is driven by government stimulus programs that are unsustainable. Additionally, global asset markets are commodities prices may be too far ahead of this move but I, for one, would rather see the trends in the “real economy” headed in the right direction.
Disclosure: No positions.