Does Impending Doom Hang Over DryShips, Diana Shipping, and Navios Maritime Partners?

Executives at dry bulk shipping companies continue to ignore this terrible risk.

Apr 1, 2014 at 12:33PM

Rates for dry shippers continue to be up in a big way on a year-over-year basis. Executives from DryShips (NASDAQ:DRYS), Diana Shipping (NYSE:DSX), and Navios Maritime Partners (NYSE:NMM) seem convinced that the celebration about healthy demand will continue unchallenged this year and next. Hedge fund manager and shipping expert Jay Goodgal maintains a different, dire view, and a recent report offers some interesting insights about why it may be lights out soon for this party.

Source: Navios Maritime Partners.

The shadow knows
Goodgal begins his report by rhetorically asking, "Does anyone remember the financial crisis of 2008?" He seems to be implying that everybody is once again playing down the imminent crisis at hand. Goodgal may presently sound like a lone voice in the wilderness, but he is convinced that another banking crisis looms overhead.

This time it's the credit and banking bubble in China, instead of the United States, that has Goodgal worried. If it collapses, demand for dry commodities would be destroyed along with it -- for example, 70% of global iron-ore shipments alone go to China. Any dip in demand would cause a dip in dry shipping rates and potentially crush the medium-term operating profits of dry shippers such as DryShips and Navios Maritime Partners, and perhaps to a lesser extent, Diana Shipping.

Goodgal warns that the shadow banking system is at risk. In March, China experienced its first bond default in 15 years; even that was a "technical default" since it was backed by local governments. This recent outright default, the first one in the country's history, involved a private solar panel company that issued the bonds a mere two years ago.

This could be the beginning of a series of defaults. A large Chinese private steel mill just defaulted on its debt. According to Goodgal, "The default, reported in the Financial Times by steel traders, sent shockwaves through the local banking and shadow banking sectors as debts were envisioned to be held by various interrelated parties in banking, coal, steel and other associated industries." It sounds like a domino effect could ensue.

Run on banks
Remember how before 2008 it was hard to even imagine a run on the banks in America ever happening again? Not only did it happen here, but just in late March it began in China with a run on two different banks. The banks were small, but the news is troubling. The local police started arresting people for spreading rumors about the banks -- a sign of possible panic from the authorities.

Goodgal reminds readers that the financial system in China is fragile, and its breakdown could seriously affect the world financial community. In turn, it would translate into painful risks for dry shipping companies and their investors.

Watch over your shoulder
The bottom line, according to Goodgal, is that "shipping will remain challenged and recovery is far off as reduced industrial and trading activity and increased deliveries cause shipping rates to remain low and shipping companies to remain financially challenged."

He ends his report with the cryptic: "And remember the prophetic words of Mr. Jean Claude Juncker, the former Prime Minister of Luxembourg, and the former Head of the Eurogroup Council of Eurozone Finance Ministers, 'When it becomes serious, you have to lie.'"

This implies that many analysts, investors, and executives do know what Goodgal knows, but they aren't being honest and admitting it. Even if Goodgal is wrong, his warnings at least sound logical, and investors should tread with caution and watch the economic news from China very carefully. By keeping a close eye on the situation, investors can get a head start on what to do with DryShips, Diana Shipping, Navios Maritime Partners, and other dry shipping stocks.

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Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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