BHP has booked 17 “Capesize” bulk ore carriers to carry its ore from the Pilbara to China next month. Normally, BHP books about 9 bulk carriers per month. But in April, BHP booked 13 and Rio Tinto 16. The armada of iron ore is relentless.

But BHP’s latest big booking may be exploiting a weakness in Rio Tinto’s flank, according to today’s Australian. Remember that last week reports circulated that the semi-official China Iron and Steel Association was calling for a boycott of Rio Tinto by Chinese steel makers. The Association pointed out that Rio was only fulfilling 82.2% of its contract obligations to Chinese mills.

That would matter for a simple reason. Last year’s contract price for ore is between US$60 and US$70. Meanwhile—because China imported a record 42 million tonnes of ore in April—ore in the spot market is going for closer to US$200. Rio said last year it would sell more ore in the spot market to take advantage of the big spread. The move was widely seen as a way of pressuring Chinese steelmakers to accept a much higher contract price for 2008 AND the so-called “freight premium.”

Hmm. If China is punishing Rio, is it rewarding BHP? Or is this a divide and conquer strategy? Either way, we have six weeks to go before a new contract must be signed. The strategies are clear: BHP and Rio want more for ore, China wants to pay less. But the tactics are sure getting interesting.

Either way, shipping rates are going through the roof. There was some anxiety about this in late January of this year, when the average daily rate for booking a Capesize freighter from Brazil to China fell to a paltry $84,000. In a Diggers and Drillers story at the time, we pointed out that this was no cause for alarm.

In our story, “A False Signal in the BDI and Boom Times Ahead for Coal and Iron Ore,” we pointed out that the slump in shipping rates, as expressed in the Baltic Dry Index (BDI), wasn’t an “abandon ship” signal for the resource bull. A harsh winter in China halted exports of coal. The power crisis in South Africa halted South African coal exports. And ships were queued up in Newcastle as infrastructure bottlenecks and flooding in Queensland dropped production volumes at Aussie coal mines.

Those three factors led to the dip in the BDI. But it’s back with a vengeance now. Daily rates are nearing $300k from Brazil, according to the Australian. In 2003, before this resource love affair between Australia and China began, rates were closer to $17k per day. Jeez, that’s barely 340 shares of BHP at today’s price.

“The dry bulk market is officially in riot mode,” says an analyst Norwegian-based Imarex. “Nearly 17 per cent of the 750-strong global fleet of Capesizes were delayed at ports over the weekend, according to the Global Port Congestion Index, which tracks ship delays,” again from today’s Australia. “Of the 129 bulk carriers at anchor, 52 are off Australia, with another 51 at ports in Brazil. Of the ships waiting off Australia, 38 are off Newcastle waiting for coal.”

Want coal, iron ore, or some other dry bulk commodity? Take a number.

Not everyone has their party hats on, though. A new report from Lehman Brothers says the commodity boom will become a commodity collapse at the turn of the year. “Once uncertainty about the physical state of the supply-demand balance clears, in terms of both inventories and spare production capacity, markets may face a sharp correction,” says Lehman analyst Edward Moore.

When predicting the demise of a bull market, it is important to distinguish between real demand and financial demand. If commodity prices were high merely because of financial speculation or foreign money bidding up Australian resource stocks, you bet we’d be concerned. And there is certainly a gathering momentum in the resource market that has just the whiff of a mania to it.

But it’s just a whiff right now. The term “perfect storm” is so overused that we refuse to use it any longer. So instead, you can think of the commodities bull as a positive feedback loop. That’s a situation where the causes of a given phenomenon accumulate and amplify the phenomenon. Boom begets boom.

Higher prices in commodities beget higher prices because they attract both investment demand (hot hedge fund and futures money) and eventually, hoarding. The great unknowns in the market are how much demand is real economic demand and how quickly supply can grow. Many oil skeptics, for example, believe there is plenty of oil in the world and that prices have taken on a fictitious life all their own.

But in the mania state of a bull market, prices become increasingly unstable and volatile as they go higher and higher, more and more removed from real supply and demand. We are clearly nowhere near that stage yet for bulk commodities or, we would argue, for oil. The boom is not yet a bubble.

If the boom goes bust, it will be because demand falls apart in China, or because the housing-related economic woes in America have a much worse second half than anyone is planning for. But right now, the new Silk Road isn’t a land route in Asia. It’s a line of Capesize haulers that stretch from Australia to China and back again.

We’ll have more specifics on oil Thursday and Friday. We’re taking a planned trip back to North America for two weeks and have decided to publish our analysis of the oil market in a two-part essay later this week. Until tomorrow…

Dan Denning
The Daily Reckoning Australia

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Source: Dry Bulk Market in Riot Mode

In fact, rumors that BHP may increase its bid have brought about even more speculation that China’s largest steelmakers will further enter the fray.

Rio Tinto Group, the world’s third-largest mining company, rose in London trading yesterday (Tuesday) on speculation BHP Billiton Ltd. will increase its $179 billion hostile bid for the company.

“The rumor doing the rounds is that BHP will increase its bid to 3.8 shares for each Rio share,” Manoj Ladwa, a derivatives broker at TradIndex in London, told Bloomberg News.

Rio Chief Executive Officer Tom Albanese rejected BHP’s initial $127 billion offer saying it “significantly undervalued Rio Tinto and its prospects.” Albanese also said the bid, which offered three shares of BHP for every one share of Rio, was not just out of the ballpark, but “several ballparks away” from being an accurate appraisal. A second offer of 3.4 BHP shares per share of Rio Tinto was also rejected.

BHP has refused to comment on the rumors, but it’s not too great a stretch to imagine another bid might be on its way. That’s because the one thing the world’s second and third largest mining companies can agree on is that Asian markets should be paying more for their iron ore.

Both Rio and rival BHP Billiton are believed to be pushing for an 85% increase in 2008-2009 benchmark iron ore prices, despite the 65% to 71% rise agreed to by Brazilian mining rival Vale (RIO).

The two Aussie juggernauts believe their proximity to Asian markets gives them greater leverage to charge higher prices.

“Rio Tinto will continue to negotiate to obtain a freight premium, to reflect its proximity to Asia and its major customers,” Sam Walsh, Rio’s chief executive of iron ore projects said in February.

Freight accounts for 30% of the landed cost of Australian iron ore in China, but close to 50% of Brazilin iron ore. China, the world’s largest steel producer and consumer, imported 383 million metric tons of iron ore in 2007, up 56.8 million tons, or 17.4%, from the previous year, the China Iron and Steel Association reported.

China’s Chess Game

China is perhaps most affected by the increase in iron ore prices. The country produces about a third of the world’s steel and the vast majority of that output is being used to build the foundation of what will one day become the world’s premier economic power. A boom in commodities prices that has caused the spot price of iron ore to triple in the past five years threatens to derail the country’s fast track development.

However, the only thing that scares Beijing more than soaring ore prices is the prospect that BHP and Rio will team up to ensure that high metal prices are supported well into the future, and perhaps through the duration of China’s economic and industrial expansion.

So far, Xiao Yaqing, chief executive of Aluminum Corp. of China (ACH), otherwise known as Chalco, has given the strongest indication that the state-backed Chinese company is uneasy about the prospect of BHP and Rio forming an ironclad alliance.

“A firm that owns too many resources is not good for the world,” he said in an interview with Hong Kong’s South China Morning Post. “People do not want to see a company dominate the market in any industry.”

Earlier this year, Chalco and Alcoa Inc. (AA), the U.S. aluminum company, bought a 9% stake in Rio Tinto Group for $14 billion. The move turned the duo into Rio’s single largest shareholder, ensuring BHP would have to obtain a 50.1% stake in the company to complete its takeover.

Last month, Sinosteel Corp., China’s second-largest iron ore trader, won over Midwest Corp. by raising its takeover bid to $1.3 billion. Sinosteel has also acquired a 2.4% stake in Murchison Metals Ltd., a rival iron ore producer to Midwest.

Few believe that Chinese companies will stop there, however. The Australian newspaper reported Monday that China’s three largest steel firms – Sinosteel, Chinalco and Baosteel Group Corp.- were looking at a 16% stake in Fortescue Metals Group Ltd., that Harbinger Capital Partners is considering selling. Fortescue is Australia’s third largest iron ore producer behind BHP and Rio Tinto.

“Harbinger chief executive Philip Falcone has been regularly contacted by many Chinese and European companies, particularly in recent weeks,” the paper said. “But because of federal Government concerns about the level of foreign investment, any sale to the Chinese will probably be for only about half of the Harbinger stake.”

Even Marius Kloppers, chief executive of embattled BHP Billiton, thinks a stake in his company will soon fall into Chinese hands.

“Various parts of China that have got surplus funds, capital to deploy, are deploying that across a wide range of things in the world,” he said at an investor briefing. “I have no doubt that one day we will see them show up on our register.”

Source: Iron Ore Proves to be the Most Coveted Commodity in the Pacific