By Nick Ristic
Asset prices booming
Across the board, commodity prices are booming. Crude has surprised many by climbing back to pre-pandemic levels, iron ore prices are at their highest levels in a decade, and prices of agricultural commodities have soared by more than 50% since mid-2020, sparking concerns over food price inflation.
Similarly, dry bulk freight rates are on fire with most markets at their highest levels in over ten years. With so many countries around the world planning large stimulus packages to spark a post-Covid economic recovery, speculation has mounted over whether a surge in consumption and apparent boom in green investment will trigger the next elusive ‘supercycle’.
Supercycle me
In the commodity markets, the term supercycle usually refers to an extended boom and bust period, spanning decades, in which prices of many commodities move in tandem. These are triggered by paradigm-shifting events in the global economy. For example, the most recent one began around 2000, triggered by China’s rapid industrialisation process, and peaked about a decade later in 2011. Within these periods of course, assets are subject to shorter term price cycles, brought on by periodic under and over-investment and mismatches between supply and demand.
For many raw materials, the most recent medium-term cycle started from a trough in 2016. This marked the end of the hangover from the late-2000’s, as a three-year deleveraging cycle in China gave way to hefty stimulus measures and boosted commodity markets. As we wrote in back in 2016 on the incoming cyclical upturn:
“It wont be plain sailing and we do not expect a cycle like 2004-2010, in height or duration, but the path of pricing does suggest that for freight and bulk commodities, the cycle has at last moved into the next phase.”
This indeed turned out to be the case, with prices picking up over the following couple of years. Taking the World Bank’s metals and minerals price index as an example, the one-year and five-year averages let us clearly see these long and medium-term cyclical patterns.
What about freight?
Dry bulk shipping markets naturally have a close relationship with these cycles. Given the inelastic nature of vessel supply, we see similar fluctuation in rates, with investment consistently undershooting or overshooting demand.
Superimposed on this pattern, China’s massive raw material demand growth in the 2000s drove a radical increase in seaborne trade, and a shipping supercycle that peaked in 2008. The upswing saw a trebling in Chinese steel production, which helped to push rates to record highs, but also excessive ordering of new ships, creating a glut of tonnage that is still weighing on the market today. Even through the medium-term cyclical uptick in 2017, this oversupply acted as a ceiling to rates. Again, using the long and medium-term moving averages of real timecharter rates, these trends are clear.
Where are we now?
While the current strength in freight and commodities is encouraging, we still believe it is very unlikely that it marks the dawn of a new supercycle. Rather than a step-increase in demand for commodities generally, we believe that many of the price movements over the past few months are driven by short term factors that will subside over the course of the year, giving way to the regular cyclical pattern.
In the iron ore market for example, many have viewed the current rally as the start of a larger trend. Chinese demand has certainly provided the foundations for the bull-run, but global demand is still shaky. Steel production shrunk by almost 1% last year, the lowest growth rate in five years. Moreover, the market is riddled with supply-side issues, which we believe are the greatest drivers of high prices. Brazilian exports, for example, have tracked below 2015’s level for the last two years, and have remained at this pace so far in 2021. Easing of these issues will bring down iron ore prices. The steel markets are also heated, partly driven by iron ore costs and speculation over output curbs in China, but also because the restarting of idled capacity has not been able to keep up with a faster than expected demand recovery. Regional deficits of steel supply are also what have driven steel trade on geared ships to four-year highs, as we reported on earlier this week.
In the grain space, we have a similar story. China’s demand has surged over the last few months as its pig farming sector recovers from Swine Flu outbreaks and industrialises. Demand has also been driven by short-term restocking and record speculative interest, after severe weather last year hit domestic production and stockpiles. US grain shipments have surged to meet this demand, but they are seasonally tapering off. Harvesting of crops in Brazil has been delayed by poor weather, and yields are expected to fall this year, adding to upward pressure on prices. According to USDA figures, total grain exports from South America are expected to shrink by almost 4% YoY in 2021, before returning to growth next year.
Expectations of greater investment in green technologies could bode well for sustained rallies for some commodities, such as nickel, cobalt, lead and copper, which are crucial to supply chains of electric vehicle producers, for example. But some of these are also being boosted by investors looking to hedge against inflation, creating a virtuous cycle of rising prices. With these factors in mind, we don’t believe that demand for goods like iron ore and fossil fuels (especially coal), which are at odds with global decarbonisation goals, will be swept up in this long-term trend.
Shipping: looking forward
Covid-19 has distorted fundamentals in the dry market. This makes it hard to gauge whether the most recent freight market cycle, which peaked around 2019, has bottomed out or is still trending down. Supercycle or not, the freight bulls would argue that the supply overhang present over the last decade has finally been addressed, and that recent stimulus measures around the world have kick-started the up-cycle earlier than would normally be expected.
The elephant in the room is Chinese economic policy, and measures to curtail risk now that growth has recovered sufficiently. China’s National People’s Congress will convene tomorrow, and is expected to set out plans to stabilise debt levels and address overheated areas of the economy, such as property. Scaling back last year’s expansionary fiscal policy will not happen immediately, but a tightening of these measures will have an affect on raw material demand.
In our base case, we remain positive on the long-term prospects for freight, owing to limited supply growth and a global economic recovery, even as Chinese growth slows. However we do expect fiscal tightening in China, environmental curbs on steel production and a sizeable chunk of vessel deliveries this year to take the heat out of markets later in 2021.
As always, for a more in-depth view of how we see the different bulker markets developing, please get in touch through your broker.