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The Vicious Cycle

The shipping markets are classically cyclical, but with extreme volatility. In fact, bulkers and tankers probably have the highest volatility of any major hard asset. The reason for this volatility is due to two main elements: the behaviour of shipowners and investors, and the relatively long build times and working lives of vessels.

Effectively, what happens to cause the cycle is:

1. Vessel earnings (charter rates) are low, probably below OPEX and CAPEX because there are too many ships and not enough cargoes.
2. Owners start to send their old vessels for demolition as they are consistently losing significant amounts of money on them.
3. Owners stop ordering new vessels.
4. Fleet growth halts or even reverses.
5. Demand catches up with supply.
6. As demand and supply reach equilibrium, any positive demand shock has significant upwards effects in earnings and vessel values.
7. Spike in rates causes owners to get excited and start buying second hand vessels at higher prices or ordering newbuilds.
8. Scrapping reduces and newbuilding deliveries increase.
9. Vessel supply increases and any negative demand shock causes rates to fall significantly, often to below OPEX and CAPEX.
10. And the cycle goes on.

This can be seen clearly in the charts below which show average earnings against average vessel values for both crude tanker and dry bulk markets, as well as second hand sale and purchase activity and newbuild orders. For simplicity, average crude tanker (VLCC, Suezmax and Aframax) earnings and values have been shown. Average bulker earnings and values are for Capesize, Panamax, Supramax and Handy bulkers.

This clear cyclicality is what the most successful owners bet on to outperform the market. Average returns in shipping are fairly low, especially versus risk profile. Therefore, owners know that timing is everything and make their exceptional returns by buying near the bottom of the cycle and selling near the top. This can be as simple as buying when values are in the lowest observed quartile of valuations and selling in the highest. However, the trick here is finding the money to buy in bad markets, as that is when most lending has disappeared. Ironically, lending tends to appear again in high markets, exactly when owners should be selling and not buying.
Source: VesselsValue

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