For months, dry shipping expert and hedge fund manager Jay Goodgal has been warning that analysts, executives, and investors all have misplaced optimism about where the rate environment is headed in the months and years ahead. While companies such as DryShips (DRYS), Diana Shipping (DSX 5.59%), Navios Maritime Partners (NYSE: NMM), Baltic Trading Limited (NYSE: BALT), and Safe Bulkers (NYSE: SB) are leaning toward strengthening fundamentals, Goodgal expects the opposite. Unfortunately, a key catalyst that Goodgal has been urging caution over now seems to be rearing its ugly head.
Loose money from China
Almost everybody in this business agrees that the primary source driving stronger rates compared to a year ago has been iron ore demand from China. Likewise, most everybody agrees that if a big drop off in demand from China were to happen, rates would likewise drop like a stone.
What Goodgal has been seeing is that the demand from China is artificial. The country has been stockpiling iron ore along with steel for construction at unsustainable levels. He has pointed out the "ghost cities", entire cities that have been constructed in which nobody lives or works.
The source of most of this artificial stimulus has been easy money and easy credit from Chinese banks along with the "Unofficial Economic Stimulus" provided by the China Development Bank. As such, Goodgal reasons the most important factor to look for in dry shipping is the economic policies out of China. As Goodgal has warned, this artificial stimulus can't last forever.
China's new dark cloud
In following economic reports out of China, it looks like Goodgal's fears began to emerge in the month of February. China's "shadow banking" loans appear to have completely stopped. As one report put it, "Fresh loans in China's shadow banking system evaporated to almost nothing from $160bn in January."
Iron ore prices in response have declined. The good news is that cheaper iron ore should help increase demand and therefore shipping volumes. The bad news is that it doesn't matter how cheap it gets if the buyers don't have the money, credit, or capacity to receive more iron ore.
There is now growing concern over credit defaults and, to make matters worse, if a slowdown in demand for iron ore does continue, there will likely be an overhang in stockpiled inventory to work through.
If that wasn't bad enough, China's top banking regulator said that new strict credit guidelines will be imposed on steel mills that have a lot of pollution or use a lot of energy. Obviously steel mills are the biggest source of iron ore demand and thus the biggest source of dry shipping rates.
Foolish final thoughts
Will a collapse in iron ore prices be enough to spark demand from China or other countries? Probably not. The weakness in iron ore prices is likely a symptom of a reduction in demand rather than something investors should expect to stimulate demand. For example, depressed iron ore prices due to reduction in demand are much different than depressed prices due to excess global supply. Supply is expected to increase during this year due to increased mining activity, so keep a close eye on further developments out of China and updated comments from analysts, especially Jay Goodgal. The developments over the next months could make or break the fortunes of dry shippers such as DryShips, Diana Shipping, Navios Maritime Partners, Baltic Trading Limited, and Safe Bulkers.