Following hedge funds hasn't been a great strategy in recent years as most have underperformed. But as the Federal Reserve stimulus tapers off and the market slowly returns to fundamentals, the "smart money" of Wall Street may soon again beat the broader market by double-digits.
And hedge funds are betting that freight rates for shipping are set to soar as demand for commodities rises, according to a recent Bloomberg report. We think they're onto something. Shipping is an intriguing prospect, especially at a time when investing profitably in the stock markets will become tougher as the Fed stimulus ends. Here we take a look at the fundamentals of the shipping industry to see if hedge funds have truly spotted a trend.
According to Bloomberg, Ospraie Management LLC and Vermillion Asset Management LLC are "among the funds that are betting freight rates for shipping are set to soar" because there won't be enough ships to handle rising global demand for everything from iron ore and coal to grains and sugar.
If rates do soar, it will be the abrupt end to a trend. Freight rates for shipping have been on a downswing since the 2008 financial crisis.
The Baltic Dry Index [BDI] is one of the most watched indicators of the shipping industry. The index is formed of weighted averages of the Baltic Capesize, Panamax, Handysize and Supramax indices. Since the beginning of the year, the index dropped more than 30% and rebounded more than 20% in the last few months (See Chart A and B) as a result of improvement in a number of these markets. Nevertheless, analyst say rates as tracked by the index would have to rise 12-fold to regain its pre-crisis peak.
Charts A and B: Is this a True Turning Point in the Shipping Market?
Created in Y Charts
The Improving Demand Picture
Still, ocean delivery of dry commodities is forecast to jump 18% between 2013 and 2016, according to ship broker Clarkson’s data. Global iron-ore shipments hit a record 1.2 billion tons last year, driven by exports to China from Brazil and Australia. Shipments of coking coal and raw materials for aluminum production saw double-digit increases last year, and soybean deliveries jumped more than 7%.
Meanwhile, Clarkson estimates that growth in shipping capacity will slow. The shipbroker projects growth of 5% this year, 4.6% in 2015 and 3.6% in 2016. If borne out, the growth forecast for 2016 would be the smallest increase since 2004, according to a Bloomberg report.
Furthermore, the involvement of private equity and hedge fund themselves are creating a consolidation within the industry that it is thought will add even more pressure on pricing in the next coming years, as the world's oversupply of ships is reduced or eliminated.
Many private equity funds are investing in ships and shipping companies because of low vessel values and tight credit markets, according to the 2013 United Nations annual review of Maritime Transport. The role of private equity funds "appears fundamental for the growth of the sector" and could result in consolidation and vertical integration of transport services, the UN study found. This is yet one more reason that freight rates should increase, we believe.
Particularly in the last 10 years ships have become bigger and the number of companies in most markets has diminished. The average number of companies per country is down from 22 in 2004 to just 16 last year, the study found. While 16 is enough to provide a competitive market for the average country, it's allowed oligopolistic markets to develop for smaller, develop! ing marke! ts, the study said.
That may be why the UN predicts in 2014 and 2015, tanker freight rates should see some improvement as cargo demand and fleet supply become more balanced.
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