China and the dry bulk shipping industry

Part 6
China and the dry bulk shipping industry (Part 6 of 7)

Why are traders in China still waiting for lower iron ore prices?

Iron ore inventory

Iron ore inventory at Chinese ports can be an important factor that affects shipping rates, since it reflects the safety net and the imbalance between iron ore supply and steel mill demand. When inventory levels are high, they reflect possible over-purchases by importers, which may prompt importers to cut back on imports in order to lighten up inventory in the near future. On the other hand, when inventory levels are low, importers may restock, which will aid iron ore shipments.

Inventory to Production Balance 2013-11-18Enlarge Graph

Inventory-to-production near five-year lows

For the month of October, the iron ore inventory held at Chinese ports stood at 110% of steel production. While we do publish inventory levels on a weekly basis, the inventory-to-production balance is a much preferred assessment indicator because it adjusts for changes in steel production over time.

Historically, the amount of iron ore stored at Chinese ports averaged around 140% of crude steel production. The figure rose to near 190% in 2011 as traders took advantage of falling foreign iron ore prices, despite cooling economic growth.

Why is inventory low?

There are several reasons why traders or companies would hold fewer inventories. This includes shorter freight duration (which reduces the safety amount that companies have to hold), increases in costs to hold inventory, or expectations of lower prices ahead. In this case, the amount of iron ore held in China is likely depressed because most expect future iron ore prices to fall as major countries like BHP, Vale, and Rio are expected to ramp up capacity and production next year.

So, if traders do increase iron ore imports next year to fill up inventory, dry bulk shippers like DryShips Inc. (DRYS), Safe Bulkers Inc. (SB), Diana Shipping Inc. (DSX), Navios Maritime Holdings Inc. (NM), and Navios Maritime Partners LP (NMM) will benefit. This also bodes positively for the Guggenheim Shipping ETF (SEA) that invests in global shipping companies.

Additional thoughts

If China’s iron ore demand growth does slow, traders may be less incentivized to increase imports by a lesser extent. Yet lower iron ore demand could prompt iron ore producers to scale back iron expansion plans future. This could cause future expectations of lower iron ore prices to reverse. Instead of falling iron ore prices, iron ore prices may actually not fall as much. Seeing this, traders may as well continue to import iron ore to bring inventory up to a normal level. This way, low inventory acts as a cushion during weak economic growth, while it opens up opportunity for more iron ore demand when activity picks up.

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