Comments Posted on June 6th, 2009 by azeem

What is going on with the Baltic Dry?

Category: finance, Tags: ,

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The Baltic Dry is as some people know is a vital index which tracks the prices being paid for dry-bulk cargo. It is a great indicator for the health of world trade.

However, trading BDI contracts was the realm of professional investors. For us mere mortal retailers, we found proxies, the most popularof which was Dryships (DRYS). Last year, as the BDI enjoyed a hideous rollercoaster as shipping rates hit upwards of $120k per day only to collapse in autumn to as low as, well nothing. DRYS has a strong historical relationship to the BDI and the stock bounced around like a yoyo, hitting as high as $114 and a low of $4 or so.

What has happened this year is that the historical relationship between DRYS and $BDI has broken down.

The charts below show the ratio of $BDI:DRYS.

This ratio had resided at 200 to 250 during 2006. In 2007, DRYS became expensive relative to the $BDI and the ratio dropped to 100-150. Today, that number stands at closer to 500.

As the $BDI has picked up reflecting greater demand for Dryshipping, this appears not to have flown through to market expectations for the dry-shippers themselves. So my hypothesis (for which I am long $DRYS) is that DRYS is cheap and worth a punt.

Unless, of course, the relationship has broken down for other reasons. Any ideas?

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  • Liquidity? Breakevens? 30 second analysis - DRYS looks like a highly leveraged play on BDI, or more precisely an OTM call option (on the BDI.) What is their 'breakeven' BDI level? Maybe it's still above the current BDI? If so this could explain the lack of movement esp. if their 'theta' is high - ie negative cost of carry due to high capital intensity. Sort of looks like the price action of a high-cost marginal commodity producer (like a junior gold miner with production costs significantly above spot.

    If this is in fact the case for DRYS, it will perform like a 20-1 shot if BDI keeps going up and crucially above their breakeven point.

    Of course I have no idea if this is right explanation or not!
  • That is a really compelling argument. Thanks!
  • Although, I should say that BDI is at levels seen in 2005, 2006 and 2007, when DRYS was at levels double of where it is today. Equally, DRYS did go on a buying spree in the past couple of years which has resulted in several write downs for the co.
  • Again don't know if its true but was guessing that (like most shippers) due to massive capex / orders in boom times, they had probably increased their breakeven BDI significantly (compared to pre-boom) and so would need an accordingly higher BDI for operating leverage to kick in.

    When you double down and lose, it's a long way back to climb out of the hole!

    Anyhow if you do, do the research let me know if my stab in the dark was close!
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