A June for the records, as Capesize rates surged 10-fold, from around 3,000 at the beginning of the month to more than 30,000, in a relentless rally that caught lot of market participants by surprise and has now brought the spot market to a new level for the year, a level that is highly profitable for a lot of owners and operators alike.
However, freight traders remain unimpressed when judged by the reaction in futures, that although initially followed the spot market higher, more recently have failed to reflect any optimism about the future: Capesize futures for the second half of the year trade at extremely steep discounts to spot and at an average rate of 18,500 versus current spot rates of around 30,000.
Are we due for a correction?
The drivers that brought the Capesize spot market to current levels remain intact, for now. Brazilian exports are increasing, Australia/Canada/South Africa continue to take advantage of the strong iron ore prices and are exporting at very high rates, port congestion is at the upper end of the historical range and owner’s sentiment has seen major improvements.
Yet, price has a way to change sentiment fast, and charterers and miners alike need to try and put a lid on the freight cost increases they have experienced in the last few weeks. That might end up being tough, as they are also under the pressure of time and the “fear of missing out” on $100/ton iron ore, so pausing activity is not a viable option.
The rush of fixing combined with high congestion has caused a tightness in tonnage. As Braemar recently discussed, the Capesize ships free and able to reach Australia near term is at multi-year lows:
With this boost in cargo volumes, available tonnage has become scarce, evident in the extremely low number of ships able to make West Australia loadings within the next ten days. Charterers in the Pacific have had to bid higher and higher keep owners from sending their ships to the Atlantic.
Looking at the futures, the third quarter Capesize futures contract has traded around 20,000-22,000 for almost two weeks now, a level we though will lead to a breather in the futures rally, despite the continuing increase in the spot during that period. We now think such a breather is overdone, and as we enter the third quarter tomorrow, the probability of a meaningful “short squeeze” in futures is increasing by the day. After all, futures settle against spot, and every day that goes by means another day of a higher potential settlement.
Although we also now believe that the probability of the spot market starting to soften has increased, we feel the discounts are wide enough to cause a rush to buy once the rate of descent slows down. (by the way, a correction is not given by any means, as a lot of market participants remain optimistic about the near-term progression of spot Capesize rates)
Futures prices as of end of June of each year
Finally, in a market dominated by hedgers and not speculators, one should not blame market participants for being cautious and selling forward. After all, time and again, this market has seen extreme volatility that causes all gains to evaporate in a matter of weeks.
Today’s strength in spot rates could be the result of positional imbalances (a theory we also partly share) but fundamentals remain favorable as the global economy gradually recovers from the pandemic, governments are pumping trillions of stimulus money to support activity, and shipping has historically been a levered play on such developments.