Ambrose Evans-Pritchard: Do freight rates tell the true story?


By Ambrose Evans-Pritchard
The Telegraph, London
August 25, 2007

The cost of leasing cargo ships to carry coal and metal to China reached an all-time high this week, defiantly ignoring a month of panic and tumbling prices across the commodity markets.

A 170,000-tonne Cape-size vessel now rents for $118,400 a day, roughly double the level a year ago. The Baltic Dry Index -- which measures freight rates and is allegedly one of Alan Greenspan's favourite barometers of global health -- has rocketed to a record 7,319.

The Baltic Index tells the underlying truth, missed amid all the headline chatter about the credit crunch, says Barclays Capital.

"Twice already this year it has proved a reliable indicator of fundamental trends for commodities when markets wobbled," Barclays says. "Once the dust settles, the likelihood is for some very strong rebounds in commodity prices."

Indeed, outside the Australian port of Newcastle a fleet of 55 immense cargo ships is still waiting to pick up iron ore and coal to supply the industrial revolutions of Asia -- a powerful rebuke to bears insisting that the great commodity boom is now over. Yet -- big caveat -- the share prices of mining companies have plummeted, many dropping much harder than those of the banks loaded with sub-prime debt and toxic CDOs (collateralised debt obligations).

Rio Tinto and Xstrata fell a quarter from their peaks in late July before recovering somewhat this week, while the smaller miners and explorers on London's Aim index or the Toronto exchange have been slaughtered.

In Canada, a clutch of mining companies have been burned by the wild ructions in the credit markets. Many had exposure to the finance company Coventree, which failed to roll over $4.8 billion (£2.4 billion) of asset-backed commercial paper last week.

Baffinland Iron Mines ($44 millio), Barrick Gold Corp ($65 millio), Ivanhoe Mines ($14 million), and New Gold Inc ($152 million) are among the companies that have not been able to get their money back -- in some cases most of their cash. (Hence the recent flight into three-month treasury notes, deemed the only safe repository)

In this climate of near panic it has become all but impossible for miners to raise loans. Credit will be at least 100 basis points more costly (1 percent) for those -- in the top tier -- still able to obtain it.

It is perhaps no surprise that mining shares have been driven into the floor.

Even so, shares are supposed to tell us something about the future, four, five, six months or more down the road.

They give warning, unlike commodity consumption, which is largely a mirror of the economic cycle. It tops when the boom tops, telling us less.

So whom do we believe: freight rates or equity prices?

The ships, says Chip Goodyear, the departing head of the Australian mining giant BHP Billiton.

Announcing roaring profits of £6.9 billion for the last year, he said the credit squeeze was having no impact on day-to-day demand for base metals -- at least from real users of the stuff, rather than funds and speculators riding the wave on the futures markets.

America may be slowing, but it is "business as usual" in China and India.

China's imports of iron ore for its fast-growing (too fast, perhaps?) steel industry reached 33.6 million tonnes in July, up 25 percent over three months.

"I would try to separate what is happening in the fundamental physical markets from what is happening in the traded markets, particularly in the short term," he said.

BHP said India would soon be gobbling up as much metal as China, citing plans by Delhi and the regions to spend $450 billion on power stations, airports, roads, and ports over the next five years to head off an infrastructure crunch.

The family of traded base metals grouped under the GFMS Index -- copper, nickel, zinc, lead, and aluminium -- have together seen price falls of 15 percent over the last month. They have dropped in tandem with global stock markets.

Copper is down from $8,300 a tonne to $7,200, yet the International Copper Study Group says the worldwide deficit was 135,000 tonnes over the first five months of this year, as strikes, delays, and lack of equipment held back new supply.

Chinese imports vaulted 260 percent to about 760,000 tonnes over the period. Stocks in LME warehouses have halved since February.

As for lead, we are down to two days of world supply. Voracious battery demand for China's car industry -- now world No. 3, producing 679,000 vehicles in July and growing at 33 percent a year -- has caused lead prices to triple to over the last year.

Robin Bahr, a metals analyst at UBS, said funds playing the yen "carry trade" had been forced to liquidate commodity investments over the last three weeks to meet margin calls or to lower risk exposure.

Investors have sunk $100 billion into the GSCI and Dow Jones commodity indexes alone (mostly in futures contracts), distorting the market.

"The metals boom is not over. The BRICs [Brazil, Russia, India and China] and the Next Billion [the next rising countries] are going to keep this bull market going for a long time," he said.

"We may lose 1 percent of global growth because of what's happening in the United States, but that means there's still 3-4percent growth in the rest of the world and it's happening in places that use a lot of metal."

If he is right, uranium may soon be ready for a rebound after slumping from $136 a pound in June to $90 as hedge funds dumped their 25-million-pound stash and Japan shut down the Kashiwazaki-Kariwa nuclear plant after the latest earthquake.

"We like uranium," said Michael Lewis, head of commodity research at Deutsche Bank. "A lot of reactors are being built and there's a fundamental tightness coming back into the market'"

China aims to build 30 nuclear plants over the next 15 years.

India is planning 19 and Russia is switching a quarter of its energy supply to nuclear power, despite Chernobyl scars.

The US is at last getting over its nuclear allergy after Three Mile Island, sketching in 17 plants over the next six years.

In total, there are 76 reactors on drawing boards worldwide -- and uranium is scarce.

Mind you, uranium was just $7 a pound in 2001. Copper, lead, nickel, and zinc were seven times cheaper. They have a very long way to fall if the world economy slips into a full-blown recession on anything like the scale of the dot-com bust.

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