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Why higher iron ore prices may negative affect Capesize Index short term

Xun Yao Chen

Panamax weighs down on Capesize, long-term remains favorable (Part 3 of 7)

(Continued from Part 2)

Price differential

When demand is strong and commodity prices are rising, shipping rates will often tag along. But shipping rates can also rise if the differences in commodity prices, iron ore for example, make it attractive for firms in China to import, rather than use domestic resources.

Low import prices

Over the last two years, imported iron ores have often traded at a discount to China’s domestic iron ore prices. Given the lower cost to produce iron ore in countries such as Brazil and Australia, iron ore miners have planned large capacity expansions in the past. These companies, trying to grab a larger share of the global iron ore market, are willing to sell their iron ore at a discount. Even if it hurts their profits, as iron ore prices come down, increased shipments could offset such negative. Furthermore, if they end up controlling a larger share of iron ore supplies in the future, it’ll increase their power to charge higher prices and achieve greater economies of scale.

Although lower iron ore prices could be attributable to weakness in demand, and in turn negatively impact the Baltic Dry Index and shipping stocks such as DryShips Inc. (DRYS), Navios Maritime Holdings Inc. (NM), Navios Maritime Partners LP (NMM), Safe Bulkers Inc. (SB), and Guggenheim Shipping ETF (SEA), it can also be driven by new supply coming out of Australia. These new supplies would be positive for stocks and ETF aforementioned.

Long-term positive

Iron ore prices have recently rallied on optimism that China’s rolling out some mini-stimulus to keep economic growth from falling further. China’s imported iron ore prices at major ports rebounded from just $105 per metric tonne to $116.50 per metric tonne on March 31, 2014. That should be positive for dry bulk shippers. While supply disruptions could also drive prices higher, negatively affecting dry bulk stocks, the relative cheapness of imported iron ore should continue to lure Chinese companies to use more foreign iron ore.

Continue to Part 4

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