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Inventory Restocking Could Help Support The BDI

August 19th, 2009 Michael McDonough

The market generally accepts that over the months’ ahead companies will begin restocking dwindling inventories.  In fact Goldman Sachs recently updated their 2H09 GDP forecast to 3.0% from 1.0% on the back of expected inventory restocking.  This will undoubtedly have a positive effect on US industrial Production, manufacturing, and ultimately US GDP growth for a period of time.  But, I decided to look into what effect, if any, this might have on shipping, and what I found was rather surprising.  In a nutshell I discovered that prior to the emerging market boom, around the turn of the century, the BDI had a very positive correlation with US imports (i.e. the level of imports went up, so did the BDI).  What I also realized was that the level of US imports was, and still is, tied very close to the change in business inventories as a large portion of these products are imported (see charts).  Over the past several years unprecedented demand growth emanating from the world’s emerging markets diminished the relationship between US import levels and the BDI, but could this relationship begin to re-emerge?  The short answer is yes, but there is a catch.

Import InventoryImport BDI

Source: Bloomberg & St. Louis Fed

As companies begin to purchase new inventories these products will have to be manufactured either domestically or abroad, which will require raw material inputs, and for those products made abroad they will have to be transported to the US.  Therefore, a significant increase in production brought on by restocking depleted inventories will very likely increase the global demand for raw materials, limiting the potential downside for shipping rates.  But, there are some concerns:  1) The timing of any potential restocking remains unclear, 2) The magnitude of an anticipated decline in Chinese demand could offset the positive contributions from replenishing inventories, 3) Given a still weakened consumer what happens once inventories are replenished? , and 4) The impact of a supply glut of new build vessels on shipping rates.  Nevertheless, I have concluded that so long as inventory restocking begins over the near-term, which I believe it will, downward pressure on shipping rates will be reduced.  But, I anticipate that the upside potential for rates will remain restrained by what’s expected to be reduced demand from China, coupled with a supply glut of new vessels hitting the market.

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