For months now, the big story in the Aussie market has been China’s Inc.’s stealth invasion of Australia through the share market. A Trojan equity horse, if you will. But maybe we had the story all wrong. Maybe the Pilbara is invading China!
BHP has booked 17 “Capesize” bulk ore carriers to carry its ore from the Pilbara to China next month. Normally, BHP books about 9 bulk carriers per month. But in April, BHP booked 13 and Rio Tinto 16. The armada of iron ore is relentless.
But BHP’s latest big booking may be exploiting a weakness in Rio Tinto’s flank, according to today’s Australian. Remember that last week reports circulated that the semi-official China Iron and Steel Association was calling for a boycott of Rio Tinto by Chinese steel makers. The Association pointed out that Rio was only fulfilling 82.2% of its contract obligations to Chinese mills.
That would matter for a simple reason. Last year’s contract price for ore is between US$60 and US$70. Meanwhile—because China imported a record 42 million tonnes of ore in April—ore in the spot market is going for closer to US$200. Rio said last year it would sell more ore in the spot market to take advantage of the big spread. The move was widely seen as a way of pressuring Chinese steelmakers to accept a much higher contract price for 2008 AND the so-called “freight premium.”
Hmm. If China is punishing Rio, is it rewarding BHP? Or is this a divide and conquer strategy? Either way, we have six weeks to go before a new contract must be signed. The strategies are clear: BHP and Rio want more for ore, China wants to pay less. But the tactics are sure getting interesting.
Either way, shipping rates are going through the roof. There was some anxiety about this in late January of this year, when the average daily rate for booking a Capesize freighter from Brazil to China fell to a paltry $84,000. In a Diggers and Drillers story at the time, we pointed out that this was no cause for alarm.
In our story, “A False Signal in the BDI and Boom Times Ahead for Coal and Iron Ore,” we pointed out that the slump in shipping rates, as expressed in the Baltic Dry Index (BDI), wasn’t an “abandon ship” signal for the resource bull. A harsh winter in China halted exports of coal. The power crisis in South Africa halted South African coal exports. And ships were queued up in Newcastle as infrastructure bottlenecks and flooding in Queensland dropped production volumes at Aussie coal mines.
Those three factors led to the dip in the BDI. But it’s back with a vengeance now. Daily rates are nearing $300k from Brazil, according to the Australian. In 2003, before this resource love affair between Australia and China began, rates were closer to $17k per day. Jeez, that’s barely 340 shares of BHP at today’s price.
“The dry bulk market is officially in riot mode,” says an analyst Norwegian-based Imarex. “Nearly 17 per cent of the 750-strong global fleet of Capesizes were delayed at ports over the weekend, according to the Global Port Congestion Index, which tracks ship delays,” again from today’s Australia. “Of the 129 bulk carriers at anchor, 52 are off Australia, with another 51 at ports in Brazil. Of the ships waiting off Australia, 38 are off Newcastle waiting for coal.”
Want coal, iron ore, or some other dry bulk commodity? Take a number.
Not everyone has their party hats on, though. A new report from Lehman Brothers says the commodity boom will become a commodity collapse at the turn of the year. “Once uncertainty about the physical state of the supply-demand balance clears, in terms of both inventories and spare production capacity, markets may face a sharp correction,” says Lehman analyst Edward Moore.
When predicting the demise of a bull market, it is important to distinguish between real demand and financial demand. If commodity prices were high merely because of financial speculation or foreign money bidding up Australian resource stocks, you bet we’d be concerned. And there is certainly a gathering momentum in the resource market that has just the whiff of a mania to it.
But it’s just a whiff right now. The term “perfect storm” is so overused that we refuse to use it any longer. So instead, you can think of the commodities bull as a positive feedback loop. That’s a situation where the causes of a given phenomenon accumulate and amplify the phenomenon. Boom begets boom.
Higher prices in commodities beget higher prices because they attract both investment demand (hot hedge fund and futures money) and eventually, hoarding. The great unknowns in the market are how much demand is real economic demand and how quickly supply can grow. Many oil skeptics, for example, believe there is plenty of oil in the world and that prices have taken on a fictitious life all their own.
But in the mania state of a bull market, prices become increasingly unstable and volatile as they go higher and higher, more and more removed from real supply and demand. We are clearly nowhere near that stage yet for bulk commodities or, we would argue, for oil. The boom is not yet a bubble.
If the boom goes bust, it will be because demand falls apart in China, or because the housing-related economic woes in America have a much worse second half than anyone is planning for. But right now, the new Silk Road isn’t a land route in Asia. It’s a line of Capesize haulers that stretch from Australia to China and back again.
We’ll have more specifics on oil Thursday and Friday. We’re taking a planned trip back to North America for two weeks and have decided to publish our analysis of the oil market in a two-part essay later this week. Until tomorrow…
The Daily Reckoning Australia