It is not often during any given year that inflection points in dry bulk can be identified, as the sector is well known for the high volatility and its unexpected twists and turns. However, as we have stressed in the last few months, especially as the spot market peaked, it was one of this instances that the bottom was easier to identify due to the timing of the rally.
Indeed, as we discussed here and here, the predicted level of the most recent bottom was a combination of the average drawdown for the index over the last several years but also the seasonal uptick in demand during the second week of June. The Capesize index bottomed at just below 20,000, declining some 56% from its most recent high with the low print being on June 8. Both of those levels were approximately in line with what we thought would be the magnitude of the correction as well as the timing of the bottoming.
All these is now behind us, and looking forward, the near term future now looks quite promising for the Capesize sector. As the chart below shows, the second half of the year has generally been more volatile and, on average, stronger that the first half during the last several years (also note the early/mid June inflection point). The major difference this time around is the strong spring rally that the Capesize sector (combined with every other dry bulk segment) has already experienced. The bounce off the early June lows was definitely stronger and more intense than other years and sentiment is definitely more constructive this time around.
Capesize Spot Rate Seasonality, 2015-2021
Which brings us to the freight futures market. For weeks now, Capesize near-dated futures have been aggressive in pricing a sharp rebound in Capesize spot rates, ignoring the deterioration in the spot market and waiting till last minute (in the case of the June futures contract) to price-in the declining spot rates. And futures traders have been right… so far. Capesize spot rates staged a sharp rebound, now standing just above 30,000, or more than 35% above recent lows just last week.
Yet, futures are indicating even a stronger improvement in spot rates over the next several weeks. And this is definitely in the sphere of possible outcomes, especially as easily shown in the previous graph. The recent range of ~20,000 to roughly 45,000 for the Capesize spot index is now the levels that traders will be focusing, and given the seasonality strength, the upper end of the range seems more likely in the near future. However, this is more or less already priced in, and sequential improvements in Capesize spot rates might not really mean much for the futures market, at least once one looks at percentage changes and not absolute numbers.
Capesize Spot Index, 2016-2021
Currently, the front month futures contract on Capesizes (July contract) is trading at the highest premium versus recent years (chart below). However, this has been the case for the last several weeks, and so far the optimism holds well. In addition, the spot market is rising, and thus traders have no reason to doubt that such premiums will not eventually be met by the rising spot market.
Difference between front month futures contract and spot index, Capesizes
So, premiums are high, sentiment is firm and the outlook is positive. That does not mean that risks are not real and that investors should sleep tight on the back of a rallying futures curve. Although commodities are in a bull market aiding freight, China is the main driver of the move and thus is also the main risk of a correction over the next several months. Macro-wise the world looks strong, but China is currently paying up significantly to secure the main commodities needed for its economy to grow. Any pullback from the current buying frenzy (see corn, iron ore, coal, etc.) and the rest of the world’s demand is not enough to maintain dry bulk rates at the current elevated levels (let alone the levels the futures are pointing to).
We are entering the third quarter with the highest Baltic Dry Index in more than 10 years and a futures curve that is pointing to further gains. The period market (time charter rates) is also pointing to continuing strength in the underlying spot market. Asset prices remain on the rise, desperately trying to catch up to the strength of the freight market.
The dry bulk cycle is progressing, we are in the early stages and absent the aforementioned risks that should always be in the mind of market participants and investors alike, the next several months will be even more exciting versus the past six months. We expect Capesize spot rates to surpass the most recent highs and reach levels not seen since the mid-2000s bull market. Volatility will remains high, and with that, potential returns will also be significant, whether someone is bearish or bullish during such an exciting period for the industry.