China and the World Drives the Commodities Boom

The Baltic Dry Index (BDI), a shipping index considered as one of the most reliable global economic indicator, has been surging up for 17 consecutive days as of Feb. 11, 09. It's not often that something just keeps going up for 17 days. The strong rally of BDI has caught a lot of attentions. However, dry bulk shipping stocks like DRYS, EXM, EGLE, GNK, TBSI and NM plummeted instead of moving with BDI. What's going on? Let me digress a bit on the big pictures before talking about specifics of shipping fundamentals.

Most people remain skeptical about the outlook of the BDI, despite of 17 days rally. Trader Mark asked "What's Really Going On". Most believe the BDI rally will be short lived. So when BDI finally dropped for two days, Bespoke Group declared "BDI rally is DEAD"!

The skeptics are wrong because they only read the news headlines but failed to study the real reasons of the BDI plummet in 2008 and strong surge back recently. They do not know the fundamental forces behind the global commodities boom and China's emergence as a major economy. The skeptics failed to predict a rebound in BDI so soon and so powerful. I correctly called the bottom and called for an imminent and powerful rebound of the BDI as well. So I am comfortable to call the skeptics wrong and predict continued surge of BDI.

Skeptics are wrong because they know what's going on in the USA, but paid little attention to the rest of the world. Chinese knew even less about the world 30 years ago. There was no TV, no telephone and you were NOT allowed to listen to foreign radio stations. Today, China has more internet surfers and cell phone users than the USA has population. Chinese teenagers are bigger fans of America's Hip Hop than American teenagers. One rich Chinese farmer bragged to live in an exact replication of the White House, down to small details. The Chinese are eager to learn everything in America and Europe, and try to imitate everything.

The internet brought easy access to information and profoundly changed China and the world. INFORMATION, not idealism, is the fundamental driving force behind the global commodities boom. China is not alone. Changes are also happening in India, Brazil, Russia, and even in the African continent. An isolated African village could remain in a primitive lifestyle indefinitely. But once they have a TV or a computer or just an outside visitor, they will learn about the outside world. They will want a better life and they will be eager to learn to acquire knowledge and work skills. They will produce something to exchange for useful products from the rest of the world. The chain reaction will leads to more developments and more demands of the world's raw materials. As I discussed before, it all started with one Chinese's visit to Texas and a cowboy hat, and now it becomes a global trend no one can stop.

INFORMATION drives the global commodities boom. The current global financial crisis, severe as it is, will NOT last as long as the Great Depression. Easy access of information allows capitals (smart money) to quickly discover and relocate to new investment opportunities.

Many Americans believe the collapse of the US economy is the end of the global economy. But we are not the whole world. The rest of the world can live on without America. The danger America faces is that the rest of the global economy can continue to boom without us, as capitals flow away from American soil to find opportunities overseas. The Obama administration's new stimulus package WILL boost demand for sure, for a while. But will it bring home capitals to generate jobs, or rather drive capitals and jobs to overseas?

President Obama: I challenged you to bring home Jim Rogers, America's best known billionaire refugee. If he comes home with his money, we have hope. If he stays in Singapore, I might as well leave, too. Please abolish FASB#157, "Mark to Market" rule immediately! There is simply no fair market value in an unhealthy, distressed and distorted market. There have been heated debate of M-to-M rule on the Bank of America (BAC) message board on Yahoo (YHOO) Finance. Abolishing "Mark to Market" is the only way to save banks.

The outlook of global shipping is bullish as China's 4 trillion yuan stimulus program is already taking effect. China's bank loans in January more than double the record set a year earlier. Steel price surged 41% from the low, indicating a booming demand again. More demand on steel means more demand on iron ore and more demand on shipping.

In recent years China's economic growth rely on growth of export to the US and Europe. But China's export remains a small percentage of its GDP. China can sustain its growth without exporting goods to the USA in exchange of US dollars. The 1.3 billion population can and will generate huge domestic consumption demand. China is pushing people to consume more.

China sells goods to the USA and then uses the dollars to buying US treasury bonds. China is basically lending money to America so we can continue to buy Chinese products. This is unsustainable and will not be sustained. Instead China should lend the money to African countries so that Africa can purchase Chinese goods and export their natural resources to China for a payback. I have been reading XinhuaNet (ChinaView) daily. This is exactly what is being discussed in China and what China is doing in Africa. Unlike the debt-laden and tapped-out US market, the African market is completely un-tapped. Africa can afford to borrow more money from China, put more money in their infrastructure building and consume more goods and services. Eventually a developed Africa can afford to pay back the debts.

The information age is narrowing the gap between people and between nations. The world doesn't even have enough commodities to satisfy the development of one China. So does the world have enough to satisfy an Africa and a South America in addition to China? The developing world is developing rapidly and looking up to a much better life standard. Does the world have enough ships to ship raw materials from Africa to China, and goods from China to Africa?

I am bearish on US dollar and US treasury bonds. I am bullish on commodities, on global shipping, and on precious metals, especially palladium. Please read my last article on palladium's fundamentals. I am heavily invested in Stillwater Mining (SWC) and North American Palladium (PAL), the only two primary palladium producers in the world. People do need to be cautious about precious metal ETFs: GLD and SLV. James Sinclair publicly questioned where GLD gets all the gold bullion. He should ask where did SLV get all the silver bars with low serial numbers (like 1,2,3). Buy physical metals, not ETFs!

Trader Mark quoted from a Lloyd's List article, which expressed skepticism that the freight rate surge could be short lived. These concerns raised must be carefully addressed:

1. Recent freight rate surge resulted from China restocking the import iron ore inventory. It will slow down as there is no evidence of increased steel demand.

Well, surely there is already strong evidences China's economy and demand on raw materials is recovering rapidly. Pay more attention to news from China!

2. Despite of a remarkable raise in percentage, the BDI at current 2000, is still far below the all time high last August at 12000.

Come on! No one expect the BDI to return to high level overnight. Nothing goes straight up or down. BDI did not fall from 12000 to 666 overnight. No one expects it to return to 12000 tomorrow. The surge from 666 to 2000 in just a few weeks is a more remarkable recovery than any one can expect. In geometric scale, the recovery is at 38% already. From 666 to 2000 is a triple. Another triple will bring it to 6000, just a leap short of 12000.

3. Huge back log of new ship orders. New ships entering service in 2009 and 2010 could expand the global dry bulk fleet by 40%, causing capacity oversupply. Refer to this article on details.

That's a good argument. But we should not take data out of context. New ships are entering service but old ships are being scrapped at the same time. During recent years of shipping boom, scrapping was almost none, as ship owners extended the services of old ships to profit from high shipping rate. Now the shipping rate has fallen, there is a sudden rush to send all the old ships to scrap yards, to bring in cash liquidity and enhance the balance sheets. In just two month, 4 million DWT tons worth of ships were sent to demolition, more than the last few years combined. Scrapping old ships is surely faster than building new ships!

Numbers from the UNCTAD review need to be taken in context. As of end of 2007, there were 10053 new ships and 495M DMT tons on the order books, including 222M DWT tons of dry bulk carriers. That was 72 times higher than it was in 2002. 72 times!!!

Global dry bulk fleet is about 600M DWT tons in size, so assuming a new ship takes 2 years to build, 222M worth of new ships will be build in two years, not counting scrapping, the increase of global fleet will be 222M/600M = 37%. That's how some analysts figured the 40% increase.

But the number is wrong! Average ship lifespan is about 20 years. So normal scrapping due to aging would remove 10% of the fleet in 2 years. The speed up scrapping of over-aged ships could remove up to 20% of the fleet in 2 years. Subtracting 20% scrapping, the increase of the global fleet is only 17% in two years even if all new orders are built.

But don't expect 222M worth of new ships in the next two years. Due to low shipping rate and lack of financing, more than 1/3 of ship orders have already been canceled. More are being canceled or delayed. Read Hellenic Shipping News, ship yards around the world are in very bad shapes. Many could go bankrupt without help.

Question: If shipyards had normal business in 2002. Now their order book is 72 times bigger than the 2002 level. That looks like an incredible booming business by any standard. Why are shipyards in bad shapes now? Even if 30%, 50% or even 90% of orders were canceled, the remaining orders would still be many times bigger than the 2002 level, not to mention the profit from cancellation fees. There are not a lot of ship builders in the world. The list easily fits on one sheet of paper. Global ship building capacity could not have increased too much from 2002 level, surely not 72 times! There is not enough space, materials, building capacity or financial backing to build 10053 ships at the same time, and deliver them within two years.

Some one must get the numbers terribly wrong. In any case, you can be rest assured that if ship builders are on the brink of bankruptcy, then we will NOT see any rush of new ships joining the global fleet in the next two years. More likely the global fleet will shrink instead.

Thus I encourage people to take advantage of recent shipping stock plummet. Buy shipping stocks like EXM, EGLE, DRYS, NM, DSX, GNK, TBSI, OCNF, SB and PRGN. I have not looked at all of them in details. But based on my study, my personal favorites are EXM, EGLE, DRYS and NM. Please do your own due diligence research.

Disclosures: The author is heavily invested in palladium producers SWC and PAL. I also hold big positions in shipping stocks EXM, EGLE, DRYS. I do not own other stocks mentioned.