Me and the boys bombed heavily at a recent pub quiz when visiting our pal ‘Farters’ Parters – the flatulent monk from old Luton Town for a catch-up last week. Parters combines religious instruction at a monastery located just off the M1 by Watford Gap services with boozing and brawling in Luton town centre most evenings. It seems that forgiveness is abound at his local, ‘The Three Legged Doberman’ – located on the vacated site of an old C&A (ahhhh, now I miss my grey ‘Clockhouse’ ski jacket on a cold winter’s day!). One of the questions that we failed on was naming a song from an extract of the lyrics. We thought that it was from a Wham! tune, but it turned out to be from the National Anthem of Great Britain. Oh well.
When my head was beginning to clear on the back seat of the early morning Mega Bus back to Airdrie, I got to thinking about what sort of questions I might pose on freight that people should, and naturally assume that, they know the answer to. So here’s one that I came up with: Starting in 2012, what is the average premium for the Capesize market over the Panamax (based on average 4 T/Cs)? Come on, you all know this one right? To be fair I didn’t and I was quite shocked at the answer, which I will give you at the end of this piece. Now no cheating, no smart phones allowed. Just guess. It will surprise you a little bit I am sure.
I’ve been rattling on over the past few weeks about the use of relative values in freight trading. I won’t do the whole spiel for a 50th time, but I will show you this table again though.
I showed it to you before, but in case that you have forgotten how it works, let me remind you quickly. This is an index of vessel values versus forward earnings (using the FFA curve). Due to some other stuff I am doing (which I promise to explain later) I have recalibrated the index figures for ease of comparison with some other stuff. The magic number is now 500 – whereby over 500 and it is better to buy the asset and sell the forward curve, under 500 and you are better off selling the asset and buying earnings (this is for a typical 5-year old vessel).
This index movement shows that while it is becoming more attractive to buy a Cape, ultimately the Supra remains by far the most attractive to own steel. Now it should not be assumed that means the Capesize sector is not interesting. This shows that it is more interesting to own the earnings, rather than the steel. If you want to go long, then Capes might be the place for you. Might be . . . but more evidence is required.
So let’s have a look at the relative values of earnings for the three ship types above. You will now see why I’ve recalibrated the index numbers above to 500 being the ‘tipping point’. Now the below graph shows you a couple of notable things once I’ve explained what you are looking at. I have calculated the standard deviation of the differential between Capesize, Panamax and Supramax average timecharter rates (as commonly published) and used an index scale of 0-1,000 to represent any given freight value against another, whereby 500 points on the index is the long-term average for that spread. Now please remember that this is not the standard deviation of the forward curves, it is based on the timecharter physical spot rate. So what you are able to do using my little ‘tool’ is to add any combination of the two and index it based on its standard deviation from its mean. With this in mind I applied it to the current FFA forward curves and it looks like this:
Apologies for the appalling quality of the image. If you want a better look at it, plus (and I really think I shouldn’t do this) I will also send you a copy of the spreadsheet so that you can play around with the data to see what it looks like at various rates and times. Note that all of the rates are below the magic 500 mean. It is telling you that the larger the ship the lower the comparable rates are. It is also telling you that the larger ships (specifically the Capes) are in the outer reaches of standard deviation as ratios. In short, it’s telling you that Cape earnings compared (in particular) to Supramax earnings are extremely undervalued going forward.
Today, yes you can say what you want about rates in absolutes. In fact today’s spot rates, when turned into the Relative Ratio Index is just 65 for C/P, 51 for C/S and 135 for P/S. A figure of 1 on the index is the furthest negative deviation from the mean that the rate pair has ever gone, and 1,000 is the highest. I’m certainly not in the ‘smartest in the room’ camp, but even I know that my chances of buying something at a tenth of its long-term average is a better deal than selling it, right? Oh, and there is time. Q4 looks good, but so do your odds out to 2019.
It might be time to get the dusty book out with all of your positions in it and just have a quick check that you are not the wrong side of this. Could you spot this from the FFA forward curves? Possibly, but see them below:
Well, it’s not the same. Can you see it perfectly? Not really (and that’s not just due to the shocking image quality!). It would imply that q4 on 2016 would be the worst place to do the spread. Using the RRI method we are trying here then it is a different story. In some senses that is a great relief because then at least all the work and effort means that we are showing something different and not visible to the naked eye.
It also dovetails neatly into what the vessel values versus earnings index is telling us, namely that shorting earnings of Capesizes and/or going long on a physical ship might actually be getting the base and the apex of your book the wrong way round.
This little back of the cigarette packet analysis does at least demonstrate that there is a lot more information to be had from looking at the prices of things in relative terms than just absolutes. In addition, one can test a current book, not just one with FFAs or ships or period tonnage, but it can be applied to bunkers, voyage, even marketing. In terms that even a dumbo like me can understand, once it has been compared, calculated and indexed then a trade at an index value of 500 is a coin flip, but otherwise you can start to establish what the chances are that a trade you are about to do will increase your probability of overall success. Or are you potentially adding more old tissues to an already blocked drain?
By the way, the answer to the question earlier is that the Capesize timecharter rates have averaged a 7% premium to Panamax, 32% premium to Supramax and Panamax a 26% premium to Supras. Is that what you expected? Probably you did as you are the smart kids, right?