Blain’s Morning Porridge, 10th May 2022: Shipping – a real world asset class, but complex!
“I am leaving the sea. I shall walk inland with an oar on my shoulder. When someone asks what it is – there I shall bide.”
This Morning – Yesterday’s ongoing pain in crashing financial asset markets demonstrates the need to diversify portfolios and decorrelated returns. Shipping is one such asset; returns have been boosted by scarcity as a result of the pandemic – the question is: can these returns be maintained?
Yesterday I promised I would look more closely at diversified non-financial assets. This morning I’ve going to start with Shipping… but let me caveat it’s a complex and expert-led market. While Shipping has massive investment potential – recent results from shipping funds have been stellar – I am not a shipping expert. Talk to shipping professionals before you risk anything in the sector.
Writing about subjects I don’t fully comprehend raises a credibility risk – but it’s worth highlighting Shipping and some other areas for the opportunities they present in terms of uncorrelated returns. One way to skip the looming crisis in financial assets will be to differentiate portfolios away from listed stocks and shares – and look to buy the real world; what we call alternative assets.
And, after yesterday’s miserable day in markets, these uncertain times means it’s absolutely necessary for investors to look outside their conventional comfort zones to generate returns. Wearing my day-job hat, I am Head of Alternative Assets at Shard Capital, so feel free to contact me on email (firstname.lastname@example.org) to ask questions – and who knows, I may have just the deal for you! (Sorry – qualified professional investors only!)
I remain convinced global stocks and shares are massively overpriced relative to the prospects for the global economy. That’s not just because of the deepening new Covid lockdown crisis in China (which threatens a catastrophic repeat of 2020-21 supply chain breakdowns), energy & food inflation, the Ukraine war, but also unravelling the consequences of 12 years of Monetary experimentation and cheap liquidity distorting markets.
Judging from the talk of capitulation trades I’m hearing, or more miserable tech results to come (Pelaton tonight), I’m not the only person thinking the crash, bang, wallop “moment” approaches.
For instance, there was a fantastic quote in Grants Interest Rate Observer last night about how DoorDash posted a 35% jump in revenues to $1.46 bln, but still didn’t make a profit – it now carries a $1.7 bln cumulative net loss. Grants’ quoted the former head of Dominos pizza: “In 60 years, we’ve never made a dollar delivering a pizza. We make money on the product, but we don’t make any money on the delivery. So, we’re just not sure how others do it.”
Which is why you should stay away from modern companies who don’t understand why successful companies never did it that way… DoorDash, and many others, will be remembered for inventing the Square Wheel…
Back to Shipping…
Shipping is an enormously complex sector. You need to understand what all the different classes of boats do, how their demand patterns work, to understand how the supply of new and old ships will affect prices, while overlaying everything with an understanding of global trade to work out likely returns. And even then, you will be swimming in an investment pool of players who will know far more than you…
Yet, the numbers are enticing. The returns from owning ships have gone skywards – charter rates have risen dramatically, ship values have trebled in some cases, and even the older ships are commanding high resale values. Funds set up to manage vessels have done exceptionally well.
Be warned: shipping can get very messy. In the past it’s been an easy way to lose money quickly – and always there will be some very clever Greeks just waiting to scoop up the bargains. Typically, it’s a boom/bust industry – every time the global economy booms there is a shipping shortage, new vessels are ordered leading a glut of capacity just as the next downturn starts.
But, shipping is absolutely critical to making the global economy function. Take a look at the crisis in supply chains…
Two of most interesting leading indicators of how the global economy is really performing are the Shanghai Export Container Freight Index and the Baltic Dry Index. The first measures the all-important freight rate and volume of Containers being sent from China around the globe, while the Baltic Dry measures the flow and price of transporting raw materials. I’ve been watching the Baltic since I was a tiny wee banker back in the 1980s.
Since May 2000 – when global trade began to anticipate Covid recovery – the Shanghai leapt from a low of 836 to peak in January this year at 5094. Now the container index has fallen to 4163 – suggesting, perhaps, that global container costs are beginning to moderate. The Baltic Dry spiked from a May 2020 Covid low of 350 to over 5500 in Oct 2021 as the global economy re-opened – it fell below 1500 earlier this year but has recovered to 2831 reflecting slowdown in China.
Both indexes correlate to inflation – which is hardly surprising as they are leading indicators of global trade. The fact both are weaker than their peaks might suggest moderating inflation and increasing recessionary conditions. Both are probably better indications of the real economy than stocks. I find it fascinating how the Baltic Dry basically flatlined through the last decade of excessively low interest rates and a raging bull equity market, reflecting the utter detachment of the financial asset universe from the reality of a very slow stuttering real economy.
When I try to understand why shipping values have risen so much since 2020… it’s complex. It’s all been about blockages as the economy reopened. The price of shipping basically depends on the availability of ships. I am told the global fleet of handy-size freighters is over 5000 vessels, but there only 5-6 actually available for charter at present!
I came across an interesting example of cost “friction” while looking at shipping. When freight costs are so high, it infers demand must be high, therefore it’s an inflationary signal – people willing to pay more to get goods.
However, the current energy/oil shock means the price of bunker fuel is pretty much at an all time high. As a result, ships are slowing down. Slow steaming requires considerably less fuel – it’s called the “cube-rule”: slow a boat by half, and it will use 1/8th the fuel it would at full speed. In the past there has been a pretty close correlation between the speed of boats and the cost of freight. When its high, ships slow.
But… things are never that simple. Slowing a boat down means it takes longer to sail from A-B. That means it costs more to hire a ship as the rental is a daily charge – and charter rates have risen between 20-35%. This is where friction comes in; shipping costs have become a compromise between rising demand, the higher cost of fuel and crew, plus the rising costs of hiring ships.
That is great news for ship owners. First it means they get paid more because their boats earn a higher rental on longer voyages. Second, its reckoned for every 1 knot (a knot is the speed of boats, its not quite the same as miles per hour) global shipping slows, about 6% of the global fleet is taken out as not available – meaning slower ships mean fewer ships for hire, further pushing up charter rates. Shipping earns more, but goods reach markets slower, thus generating inflation!
The next problem is global ports. From Shanghai, Long Beach and Harwich global ports were swamped by the post-Covid reopening. This was exacerbated by shortage of lorry drivers, stevedores, and now renewed lockdowns in China. While Western Ports are full of empty containers, there are practically no empty TEUs (Twenty Foot Equivalent Units) anywhere in Asia. The result is massive delays unloading vessels. About 20% of the Global Shipping container fleet is currently queued waiting for entry to the big ports – again creating scarcity and pushing up charter prices.
All of which is great news for the owners of smaller Handysize vessels – we’re even seeing smaller bulk carriers carrying containers to smaller ports (many have their own cranes on board). It’s not particularly efficient, but it solves the immediate transport crisis.
There are other problems – about 3% of the global merchant marine is Russian flagged, but Russian sailors make up 10% of the 2 million odd global merchant sailors. Following the pandemic its clear many sailors have retired or have given up – many were effectively trapped on board for the duration of the crisis. There is a massive shortage of crew and officers building – by 2025 we could be short over 90,000 officers, particularly in engineering – a long term problem for the whole global economy.
The question for investors is this: will the current global supply chain problems which have driven up shipping prices ease, and mean prices, and therefore returns, continue to drive results? Perhaps, but the problems will be solved in the medium term. Its not necessarily bad for shipping – in many shipping classes the ships are getting older and less efficient, and new fuel and environmental regulations mean they need replaced.
The numbers are all out there.. but this is where you need the expert advice on which shipping types are likely to prove most valuable. I’ll be very happy to assist. For instance, I am reliably informed not to buy container ships, but handysize bulkers… and maybe some tankers…
Five Things To Read This Morning
Out of time, and back to the day job..
Strategist and Head of Alternatives, Shard Capital