With the Baltic Capesize 5TC index reaching its highest level since July 2015 and approaching long term upper range resistance, the question to be asked is are we about to break out into genuine trending conditions?
The number of Capesize vessels in service is as great as it has ever been at 1,676 vessels. However, this supply is matched by iron ore exports from Australia which have increased from 20m tonnes a month in 2009 to over 70m tonnes a month by late 2016. At the same time vessel deletions have averaged around a 5.14% increase per quarter for the last eight quarters, suggesting that owners are continuing to rebalance their fleets.
Other positives for the Capesize market come in the form of the orderbook as a percentage of DWT. At 11.26% this is as low as it has ever been and is matched by the number of vessels under construction. At 47, this is the lowest level since March 2014 and close to the recent historical lows achieved in May 2014, which were at the time at an eight year low of 38.
The Capesize model is starting to balance out, newbuilds are still exceeding deletions, but that spread is narrowing, and getting ever closer to equilibrium. Although healthy, the Capesize sector is still very vulnerable to even a minor slowdown in Chinese steel production.
Domestic coking coal prices in China continue to remain steady as does the domestic scrap price (-2%), meanwhile the Chinese domestic hot rolled steel sheet spot price has dropped an average of 12.23% since February 21. Iron ore has replicated this, dropping 14% in the same period.
The resilience of scrap and the domestic coking coal levels has resulted in steel mill profit margins dropping from US$80/tonne to below US$10/tonne. The driving force behind the lower domestic steel price will be Rebar and HRC inventories, as these are at their highest levels for two years.
The inventory build has been aggressive, but it has also been seasonal and can be expected to draw down over the coming months, easing some pressure on steel margins in the near term.
For the Capesize index, the inventory build-up has been a key factor in recent months. The aggressive build-up has maintained a healthy demand for iron ore and produced stronger freight rates. However iron ore imports have a tendency to decline between May and June when taken on a three to five year average, whereas Capesize rates tend to be fairly stable. This would suggest that rates may be ready for a corrective phase, setting the market up for a more bullish trend further down the line.
The upward swing in the Capesize Index has now been in play for seven weeks. In recent years it has had a tendency to enter a corrective phase between week seven and week nine. Weakening profit margins at the steel mills in China would support this in the near term. However a more balanced freight complex has reason to cheer, the corrective phase this year will be at substantially higher levels than of recent years.
This bodes well for the longer term health of the market, when iron ore imports into China pick up in the second half of the year, the Capesize Index should be playing from a position of strength.
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