The ongoing correction in the spot Capesize rates has left freight futures traders in a particularly odd position as it relates to the progression of the spot market. From one hand, the strength in the sub-cape segments should provide much needed support to the larger ships, and thus the correction might be just technical and a recovery is just around the corner. After all, with the futures market at a 40% contango to spot, market expectations are that coming Q3, Capesize rates will return to their average historical relationship with Panamaxes (Capesize rates at ~1.45x Panamax rates). However, Capesize spot rates currently appear rather weak, and although things can change rapidly, futures premiums are approaching record high levels.
The market has been there before. Hope is not only part of the market narrative when it comes to freight (after all, there is no “carry-trade” in freight, unlike other commodities) but the blurry picture of the short term demand/supply balance leads to such a “strategy” quite often.
However, it is not all bad when it comes to premiums. Physical freight traders can capture part of the spread between futures and spot (although basis risk is high), and thus potentially turn the spot market around IF the balance is tight enough at the time. So, are we in such an inflection point today that the premiums in paper can lead to a turnaround on the spot index and possibly reverse the recent slide?
Running the risk of an outdated post by tomorrow (after all, spot rates can move a lot and very fast), we might be closer to such a turning point that most people expect. The Capesize Pacific market seem to have found a bottom, while the rush to cover cargoes prior to the fiscal year end for some Australian miners (a few companies have June 30 fiscal year) could potentially push the market higher, albeit short term.
In the Atlantic, the balance is fuzzier, as a combination of strikes, port delays and expectations for higher iron ore exports out of Brazil makes short term predictions tougher. Recent information points to an end in the Colombian coal export strike as Cerrejon is set to resume coal loadings. Up in the North, the strike in Port Cartier is still going on, but such events tend to not last long, so we speculate that such a disruption will also soon end (although we have a low confidence on such a prediction). Year-to-date, iron ore exports out of Brazil are tracking some 12mt higher versus last year, which is mainly due to a strong January figure (and partly March, though the y-o-y comparison of the pandemic skews such figure). Still, more needs to be done for expectations to be met, and in any case, the ramp up last year during Q3 and Q4 was considerable (some 10mt increase in Q3 vs Q2).
So, the market is not only “hoping” for a reversal in the declining Capesize spot market, as there are valid reasons for such expectations. Yet, we are reaching the point of a skewed risk/reward, as the premiums in futures are record high with the upside potential lower that the underlying risk, in our view.
On the other hand, this year has been anything but normal. Q1 spot Capesize rates averaged 17,000, one of the best performances in several years while Q2 is tracking close to 30,000, a very high level only comparable to the 2000s bull market. As a result, the premium assigned to Q3 rates is warranted if one looks how the first half of the year has already developed.
Only time will tell which way the “spread” will ultimately close. We remain of the view that the Capesize market will bottom by mid-June before turning up again. In shipping, timing is crucial, but impossible to pinpoint. Yet, we would not really sweat over precision. Fundamentals remain strong, volatility is abound, and even if the absolute bottom happens sooner than later, the opportunities for investors and traders alike are still there.