Big Danger or Big Opportunity?

Ghosts and goblins are so old-school. Here in the 21st century, we've got some new Halloween demons that will haunt your dreams -- and your net worth -- in true nightmarish style.

Take, for instance, the Baltic Dry Index. No, it's not a new kind of extra-cold ginger ale. The BDI is an index that tracks shipping rates -- in the cargo-ship sense -- around the world. The supply of shipping isn't very elastic -- ships are expensive, so the total number doesn't change a lot from year to year. That means rates are very responsive to demand. When demand is high, and all the ships are full, shippers can and do charge a significant premium. That's a sign that global trade is healthy.

And when demand is next to nothing, shipping gets very cheap. Like now. The BDI peaked at 11,793 this past May. On Thursday, it was at 885. That's not a typo. Now, to be fair, prices were way overheated earlier this year, and the current lows aren't unprecedented -- though there are ships out there that are being chartered for less than their operating costs.

That's got to hurt
Yes, the shippers aren't having much fun these days. If you thought your 401(k) had taken a hit, pull up a one-year chart on a major global shipper like Excel Maritime Carriers (NYSE: EXM  ) or DryShips (Nasdaq: DRYS  ) . DryShips' 52-week high was $121.44. It's under $17 as I write this. The P/E ratio on that stock is 1. Ouch. And no, that's not an automatic buy signal -- earnings will likely catch up with the stock price soon enough.

Why has demand dropped so sharply? Well, you may have noticed that commodities prices have fallen sharply across the board. That's largely attributed to "demand destruction" -- the expectation that people will buy less of everything during a recession.

But some are arguing that part of that demand destruction may be due to the inability to finance these commodity cargoes. They point to the big drop in the BDI after Lehman Brothers went bust. So is the global credit crunch playing a role in lower shipping rates?

One more credit crisis
The credit crunch affects commodities and shipping in lots of ways, but one underappreciated factor is the issuing of letters of credit. These instruments, another form of short-term commercial credit, are key to international trade.

Here's how they work: Before Company X ships goods to Company Y in another country, Company X (and the shippers) will want some assurance that Company Y will pay for the goods when they arrive. That assurance is given via a letter of credit, a note from Company Y's bank to Company X's bank saying, in essence, that Company Y pays its bills, and if it doesn't, in this case the bank will cover it. (If Company Y pays in advance, the letter goes the other way, giving assurances about X. There can be many other complexities, but that's the basic process.)

And just as the commercial paper market has all but grinded to a screeching halt in recent weeks, so has the issuing of letters of credit, for the same reason -- banks don't want to be exposed to risks from other banks.

If you're a commodities exporter like iron ore producer Vale (NYSE: RIO  ) or diversified commodities giant BHP Billiton (NYSE: BHP  ) , that's a problem. The argument goes like this: If I can't get credit to get iron ore shipped to me today, then I'm not buying iron ore -- and "demand" has dropped.

In danger, there is opportunity
So is this a disaster in the making? Probably not. While theoretically, global trade could be cut back sharply -- Smoot-Hawley revisited, in effect if not in intent -- it doesn't seem likely. Just as government intervention is finally starting to unstick other corners of the credit markets, I expect that this problem will either unstick along with the rest -- or draw a bailout effort of its own, sooner rather than later.

And when that happens, commodity prices could see a bounce as local supplies get replenished and stalled projects get underway again. While a return to the bubble levels of earlier this year seems unlikely in the near term, commodities exchange-traded funds such as Market Vectors Global Agribusiness (AMEX: MOO  ) , PowerShares DB Base Metals (AMEX: DBB), or a more broad-based fund like iShares S&P GSCI Commodity-Indexed Trust (AMEX: GSG  ) could see a nice gain from present levels as this problem subsides. 

To read more about opportunities in the global credit crisis: 

Worried about the global economy? Looking for international opportunities? The Fool's Global Gains newsletter team has been watching recent events unwind and has found tremendous opportunities within the chaos. Get invested today -- see its best stock picks right now with a 30-day free trial.

Fool contributor John Rosevear has no position in the companies mentioned. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 01, 2008, at 10:48 PM, reachsean1 wrote:

    I have been reading some of the article from Fools .com.Almost under each stock in yahoo 's finance and I can say this with 99% certainty that these articles are the most confusing and two way talks have ever seen .

    I have became a primum member and bought Netgear when you guys recomended it at 32 dollars and lost my shirt on it ..

    I think that you choose the section of the comments from your users and publish under fool.com very very irrisponsible of you and your site ..

    You are talking about Gloom and DOOM for shipping company called DRYS .

    PLEASE read this article about Bulk Shippers..

    http://www.bullishbankers.com/whats-next-for-the-bulk-shippe...

    maybe you should read it before writing your article .ABOUT drys

    Dryships [DRYS: 19.25, +2.08 (+12.11%)] is an interesting play because it is no longer a pure-play bulk shipper. Dryships recently acquired Ocean Rig and has entered into the ultra deep water drilling market. This separates them from the rest of the competition, and in theory this acquisition should actually make the stock less volatile. In most cases dry bulk shipping companies will hedge a much smaller percentage of their revenue than drilling companies. This component should be able to tame the rapid movements of Dryships after the integration is complete. The long term fundamental outlook for the deep water drilling industry looks strong, especially since the Brazilians and Petrobras [PBR: 26.89, -0.13 (-0.48%)] have not be able to contract enough drill ships to fully exploit their deep water reserves.

  • Report this Comment On November 02, 2008, at 7:38 PM, lcwilliam wrote:

    I have to agree with the previous post... fool.com has burned me on everything from GFA and JLL (both global gains picks that are DOWN 60%+).

    Netgear is another one which fool.com said was one of it's top picks for 2008 --- this stock has gotten murdered (down 70%).

    All of these picks show that fool.com was way off the market in regards to the credit crunch and the cut back in consumer spending. If they had anticipated either one of these events they wouldn't have recommended any of the above three stocks.

    If these are fool.com's best picks, than I'd hate to see their worst picks. Thank goodness I didn't get conned into their pricey newsletters.

    On a bright note, finally some education in a fool.com article -- the letters of credit explanation is very helpful in insightful.

  • Report this Comment On November 04, 2008, at 10:13 AM, capesize wrote:

    in simplictic terms the article gets half way to the point on dry cargo shipping. but note there will be no short term recovery for the dry cargo shipping industry which has been over built by other peoples money and the downtern in the mentioned BDI has been hastened by the unavailability of credit. also dont gain confidence from cross industry investments by stock listed companies into other sectors of shipping. the present low levels spread across all sectors and there is more trouble ahead. some of the listed companies will return good results but their destiny is governed by the quality and stability of the counterparrties they have contracted their ships with and in these uncertain times anything is possible. if your holding shipping stock hold on for the ride and in the case of greek companies expect the owners to start buying their own stock back at the bottom of the market. otherwise no massive gains can be envisaged in the short term but better volatility will return after Q1 Q2 next year

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