Mentioning spot shipping markets is not possible without mentioning how highly volatile they are. Pierre Aury explains.
The Oxford English Dictionary defines something volatile as something liable to change rapidly and unpredictably.
Volatility is defined as the annualized value of the standard deviation of daily returns over a three-month trailing and rolling period.
The graph shows that we have had since 1985 three clear periods from a volatility point of view: 1985 to 2003 – a period of low volatility with an average volatility of 10% over the period; 2003 to 2006 – a period of transition with an average volatility of 20%; and since 2007 – a period of high volatility with an average of just north of 40%.
It is worth noting that the graph above shows the BDI which is a basket with some of its individual components being way more volatile. For example from 2020 to today the volatility of the BDI has been 57% when at the same time the volatility of the capesize 5TC insane has been an insane 122 %.
The explanation for this extreme volatility is to be found in a combination of features of the freight market.
Freight is non-storable: it has to b.e used or it is lost, a bit like electricity which is as well for that reason a highly volatile market
Shipping markets are also still very fragmented which adds to volatility.
This high volatility is magnified by the development of the forward freight agreement (FFA) market. Before 2003 there was no meaningful FFA market. In 2003 clearing was finally accepted by market participants and since that time volumes have increased a lot to the extent that the FFA market now can have a massive influence on the physical market, amplifying any up or down movements.
Going back to the definition at the top of this column, yes, the dry bulk shipping spot market does change rapidly and more rapidly today than ever. That is one box ticked. But does it change in an unpredictable way or in a more unpredictable way than before? This brings forecasting into the picture. A trade direction comes from the relative position of a proprietary forecast and a public forward curve. For a given time bracket a trader will go long if his forecast is above the forward curve and short if his forecast is below the curve. So there’s no point going to the office and trading without having a forecast.
Does a higher volatility mean that forecasting is more difficult today than yesterday? We need to consider that the outcome of the forecasting process is very simple as it is binary: the spot market either goes up or down, basically a flip of a coin. A forecast doesn’t need to be right all the time but right more often than wrong. Noises such as strikes leading to congestion, storms delaying ships, bad weather affecting harvests, greed in financial institutions triggering financial crises, wars changing trade patterns are driving the spot market way more than supply and demand.
The world is vastly more complex with many more lunatics in power today than in 1985.
The fleet is massively bigger but we have today a huge supply of available data and powerful means to process them. Remember 3.5-inch floppy disks were introduced in 1981.
The answer to whether forecasting is more difficult today is probably no As for the genuinely unpredictable stuff, it has to be dealt with by a robust in-house risk management system.
