Commodities rally, Baltic Dry Index still gloomy

The prices of major commodities are strengthening including that of iron ore, copper, crude oil. But, surprisingly, the Baltic Dry Index is showing weakness on weak bulk shipping prices. Growth in global industrial production is rebounding at the strongest rate since 2000 but the freight market is lagging. This is because after decades of minimal new dry bulk carrier supply, fleet additions have picked up strongly and the total bulk carrier fleet is expanding rapidly, according to an analysis by Bank of America-Merrill Lynch (BofAML).

Dry bulk tred is set to strengthen this year with a growth of 7%, compensating for last year's demand destruction. However, dry frieght prices will not spike due to overcapacity of ships. The global iron ore market is tight and seaborne demand is growing rapidly, particularly from China. Moreover, the global coal markets are starting to show signs of tightness with API4 coal prices rebounding to 18-month highs. Therefore, in the medium term, dry freight prices could climb up, once the oversupply of ships is absorbed in 2011, BofAML analysis said.

BofAML said that the term structure of the freight market will remain in backwardation. Implied volatilities on dry freight contracts remain relatively high, particularly at the very front end of the volatility term structure. Hence, overwriting options over a long freight position could generate a stream of income to complement exposure to flat prices. more...