The Baltic Dry Index revisited

The Baltic Dry Index is a strange animal.
Some analists think that it is a measure for international trade flows.
The Baltic Dry Index, or BDI, is an index that tracks a blending of rates to ship dry goods - basic raw materials like iron, coal and grains - on three different-sized boats on the four main shipping routes.
Conventional wisdom - or perhaps just tradition - has analysts looking at the BDI as a leading indicator of how commodities and the global economy will perform. The old adage is that no one hires a ship unless they have something to transport, and if people are transporting things, that means they're buying and selling.

However, the correlation between commodities and/or stock indices seems to be weak. Even when you compare the BDI to the shipping companies themselves the relation is minor. Look to the Claymore/Delta Global Shipping Index ETF (ticker: SEA).

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Swedbank ... what's in a name?

More trouble for Baltic countries as S&P downgrades Latvia and Estonia. What more has to come? At the end they will follow the IMF in order to obtain a financial Life line.
Is there any choice? Look to Latvia which saw its GDP for 2009Q2 contracting with another 19,6% after a drop of 18% in quarter one.
Look to the SEK. Given the high levels of Swedish banking exposure, the Swedish banks are not out of the woods. Neither is the country.
‘Swedbank sweats’ was the Financial Time titling this morning as loan impairments originating from the Baltic region are still growing meteorically.

Not good at all.

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Baltic Dry Index and China

We mentioned the collapsing Baltic Dry Index yesterday and illustrated this with a chart of the soaring inventories in China of iron ore. The warehouses are full and this is bearish for iron ore, BDI and the AUD.
But….
When the stockpiles are considered as a % of steel production (and thus as a "stock to consumption" ratio), the figures are less alarming. You can see below that Steel production has rocketed higher as well, and iron ore stockpiles this year are actually lower as a % of total steel production (144% vs 157% according to our commodities team). So this steel production chart is a big mitigating factor when considering the Iron Ore and BDIY charts

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Goldman Sachs, Baltic Dry and China

From Goldman Sachs Tim Read

Recent weakness in BDI has stemmed from a quiet period in fixing mainly Brazilian Iron Ore cargoes and easing in Chinese Port congestion. With more coal going East not West out of South Africa the number of ships in the Pacific Basin has increased and while this tightens the Atlantic basin we have not see sufficient Brazilian cargoes to support the overall market. We have also seen more new builds enter the market and these are all in the pacific.
All that being said Vale are looking to bring out some more cargoes which should help support the market. We are entering the time of year soon where we will start to see USG grain exports and coal for winter heating. Chinese Iron Ore and steel prices are only going up and demand for steel there seems unstoppable. The new builds are about 40% behind the delivery schedule so fleet growth not as bad as initially feared at the beginning of the year. European steel mills are slowly looking like they are coming back as Ore stocks are drawn down. Looking at the BDI vs just about everything else; Aus Dollar, Asian Equity and other commodities BDI looks underpriced. So the big question is whether the BDI is a leading indicator or just on a temporary blip down. I'm leaning towards the latter as feel the above bullish factors will bring the dry market back up. The rate of decline in the spot freight rates has eased and could easily see a tick up from here.

And more:

This picture shows the total amount of iron ore held in all Chinese ports. So this is a very interesting measurement of Chinese stockpiles. The units below represented in the figures are 10,000 tons. This is released weekly on Mondays for the previous Friday, so it is very timely info. As you can see this number, which has apparently only been released since mid 2006, that iron ore (the key component for steel production) stockpiles have almost breached the level of their last peak reached in 5Sep2008, just before Lehman. So sure, the stockpiles could bolt to all time new highs, but more realistically warehouses are probably pretty full and that is why the Baltic Dry Freight Index has plummetted 37% of late in expectation of less demand to ship more iron ore (and other commodities) to China.

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Baltic Dry Index

We have written it before: the Baltic Dry Index went up only because the demand from China was huge for ore and other bulk freight.
Last week however, the index lost almost 20%.
Is this movement the precursor of something else?
Or is a rebound imminent…

Since its high for 2009, this index has slumped with 35%.

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Baltic Dry Index

You hear very seldom about it, but there exists an active trader network trading the Baltic Dry Index. The magic number there is 4000. Now it seems that dry bulk shipping rates for things as iron ore, coking & thermal coal and grains are cooling down a little. The only reason the index has held up so far is the congestion in Chinese ports and the port inventory build going on in the same place. Odds are that declining steel and seaborne iron ore trade will be a major headwind for this sector in the second half of this year especially after de spectacular growth of the bulk shipping fleet last year.

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Is the Baltic Dry Index deceptive?

Attention folks: while Chinese imports of iron ore have been up 25% since the start of this year, Chinese steel production is only up 3%. What’s happening? Inventory build-up for sure.
So be careful for those who think that the Baltic Dry Index is an indicator of economic activity. Maybe it is but also maybe not.

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The Latvian pressure cooker

The Latvian pressure cooker is still on the stove.
We know the story: Latvia, the former Eastern European tiger, pegged his currency to the euro in order to speed up growth a little. Than the financial crisis came and Latvia found itself badly caught out. Credit was needed but the attempt to issue 100 million LAT-denominated bonds resulted in no takers. In normal times and countires you devalue the currency. But that will cause trouble in Europe. For starters: Swedish banks lent heavily to Latvia and once the devaluation cascade starts, these banks will be forced to take big losses. Than there is the fact that nobody knows what will happen to neighbor countries and farther south once the currency peg will be broken up.
The Swedish Central Bank borrowed this morning 3 bln EUR from the ECB. The Riksbanken has already a swap agreement in place with the ECB of 10 bln EUR. Now why do they do this?

Now, let’s have a closer look to European banks. Total lending to emerging markets is now some 4.7 trln USD. 74% of that came from European banks. The Netherlands and Austria are the countries lending more than 50% of their GDP to these emerging countries.

We read this morning

IMF director Dominique Strauss-Khan said that Mexico, Colombia and Poland face challenging financing deficits that if not corrected soon, could put them at risk of defaulting. The external financing needs of Mexico and Colombia have been met for 2009. In this regard, the comments of Strauss- Khan seem strange and could add noise to the markets. . . .
The comments of IMF’s Strauss- Khan are particularly inopportune but should not be taken seriously. The IMF hasn’t published a formal press release confirming the fund’s view. Mexico is still investment grade and it is very unlikely that any of the three major rating agencies decide to lower it to junk.
Mauro Leos from Moodys said a couple of weeks ago that “it was far fetched to believe that Mexico would lose its invest grade category any time soon”. The view of the rating agencies has been that Mexico needs to pass structural reforms to avoid a downgrade. Shelly Shetty from Fitch commented recently that Mexico would need a plan “B” in case Congress fails to approve a fiscal reform after the July elections in order avoid a downgrade. This amounts to sort of running in order to stand still.
But the prospects for comprehensive fiscal reform are very slim. In fact, the two major political parties: the centre left PAN and centre-left PRI have both said that they are not at all interested in passing a fiscal reform package. While no party is expected to publicly say that it favors increasing taxes particularly before the congressional elections of July, the political climate does not support the passing of any reform.
Mexico will be downgraded by one notch on the back of deteriorating fiscal revenues as the economy contracts to between -5.5% and -7.5% this year. Still the comments of Strauss- Khan add noise to the market. . . .

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Don't cry for me, Latvia

We still look to the problems in Latvia. A lot of people assume that the crisis will be small and manageable. Nothing special.
We fear that – as what happened in 1998 – there is a lot of potential that this crsis can spread very quickly over Eastern Europe and that the EU will react too slow to prevent this. The financial version of the swine flu.
Here is an excerpt from an article of Anatole Kaletsky from last week. Anatole is writing for The Times.

Europe is now in the middle of a perfect storm - a confluence of three separate, but interconnected economic crises which threaten far greater devastation than Britain or America have suffered from the credit crunch: the collapse of German industry and employment, the impending bankruptcy of Central European homeowners and businesses; and the threat of government debt defaults from loss of monetary control by the Irish Republic, Greece and Portugal, for instance on the eurozone periphery.
Latvia, partly because it has followed an Argentine-style policy of “fixing” its exchange rate and encouraging its citizens to borrow in euros and Swiss francs, is now in the front line of the battle between governments and financial markets - and a humiliating devaluation looks increasingly likely. Last weekend a former Swedish finance ministry official brought in by the Government as an adviser admitted that devaluation was no longer a matter of “if” but of “when and how”. If Latvia does devalue, then the two other Baltic states will almost certainly be forced to follow and the panic will probably move to Romania and Hungary. Beyond that, the contagion is likely to spread to the weakest members of the eurozone - Ireland, Greece, Portugal and probably Austria.
If the crisis expands, other EU governments - and especially Germany’s - will face an existential question. Do they commit hundreds of billions of euros to guarantee the debts of fellow EU countries? Or do they allow government defaults and devaluations that may ultimately break up the single currency and further cripple German industry, as well as the country’s domestic banks?

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Latvia

The End.
So far for the city of Riga.
Crisis is brewing.
The Baltic will burn anytime soon now.

RIGA, June 3 (Reuters) - The Latvian treasury failed on Wednesday to sell any of the 50 million Latvian lats ($100.7 million) of various treasury bills offered for sale on Wednesday, the stock exchange said.The failure to attract offers for the paper came as the Latvian market remained frozen due to worries about the currency, which some fear faces a devaluation, and amid central bank buying of the lat to keep it within its peg to the euro.

The euro peg will be abandoned in the next days. The FX markets smell the smoke and are selling the Swedish Krona, the Zloty and so many others versus the euro.

From RBS Research:

Net-net though, and whatever your view of fixed exchange rate versus floating regimes, the current status quo is clearly unsustainable, with local rates up thru 100%, and the Bank of Latvia bleeding FX reserves. Time is clearly running out. While devaluation is not without costs, it would clear the air, and in a trade off with the current huge pace of real GDP contraction/mounting fiscal problems surely cannot be much worse than the slow death being wreaked on the Latvian economy by fixed exchange rate orthodoxy.

The original reason for the introduction of the currency pegs was to provide the fiscal foundations and stability to help satisfy the Maastricht criteria essential for euro membership. But the current parlous state of the Baltic nations’ finances and the reality that their economies are in a collective stupor make it hard to see the rationale in retaining fixed exchange rates; euro accession is now categorically not imminent. Who will be first to realize they have little to lose by dropping the peg?


Hardest hit once this mechanism gets under way will be the foreign lenders. Swedish banks but also others because the value of their loaned assets will decimate. The credit, supplied across the Baltic region will dry up and cause another crisis with the banks involved.
Now what if the Balkan follows later?
For starters: think about Belgian bank KBC, Italian Unicredito and others – AIB? -

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Titanic

According to Bloomberg: About 45 percent of U.S. rigs have been shut since September, which means fourth-quarter gas production will tumble 5.2 percent, faster than the 1.9 percent decline in use, the Energy Department forecast. Prices will rise to $7 per million British thermal units by January from $3.897 today on the New York Mercantile Exchange, according to a Bloomberg News survey of 20 analysts. The gain would be the largest since the first half of 2008.

But this is Bloomberg.
We become a little prudent as prices are going nowhere.
Last weeks we mentioned natural gas and copper.
All their upward price movements are stalled.
Even de Baltic Dry index is not going higher for the moment. Now be careful with charts where you can click in the box for a log scale of not.
As markets are at the bottom charts without logarithmic scaling are less sexy than with a log scale.

But anyway…

Rapidly deteriorating conditions in the shipping sector are squeezing the ratings on European banks exposed to the shipping industry. Many shipping companies are struggling following a sharp downturn in global trade and challenging funding conditions. We expect these difficulties to result in a material increase in banks’ loan loss provisions. We see pressure on banks coming from an increasing number of loan defaults, rapidly deteriorating shipping company credit quality, and weaker recovery expectations due to falling asset values. In addition, we believe banks’ capital ratios may decline as deteriorating creditworthiness feeds through internal rating models and increases the relative risk-weighting under Basel II.

European banks are especially exposed to drybulk and container shipping, the fundamentals of which are “particularly weak.”
The S&P analysts highlighted seven banks with significant shipping exposures - DnB NO, DVB, KfW IPEX-Bank, NIBC, HSH Nordbank, Norddeutsche Landesbank Girozentrale and Nordea.

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