Pullback in DryShips Creates a Second Chance

The dry bulk shipping stocks have popped up on our radar once again, as the Baltic Dry Index has started to rise anew. The move is attributable to the successful conclusion of iron ore negotiations and the surging prices for coal and grains.

The main products shipped by the dry bulk shipping companies are iron ore, grains, and coal. If you've been following the recent action in the commodity markets, then you know that demand for all of these products are surging higher.

The conclusion of negotiations for 2008 iron ore prices resulted in a 65% increase in prices. Agricultural commodities continue to rally as a growing global middle class demands more food. Coal prices are also strong as China has flipped from being a net exporter of coal to a being net importer. As these bulk commodities get shipped around the globe, the dry bulk shipping companies become the benefactors.

Baltic Dry Index

Click here for larger image.

The Baltic Dry Index took an extremely hard hit in November of 2007 as traders created a "blow off" move in the index on fears of a shipping shortage. The index then collapsed on fears of a domestic recession leading to a global slowdown.

Since then we have seen shipping rates reverse and move higher, fueling a 40% jump in the Baltic Dry Index in the last two months. It's too early to call this a complete recovery in the index, but the return of strength in shipping rates is encouraging.

The dry shippers are certainly enjoying an extremely profitable environment and we should see this strength reflected in earnings going forward. The Achilles heel to this scenario is a protracted domestic economic slowdown which eventually drags down the global boom and pushes other economies into recession.

Traders that step into the dry shippers on the long side at this time are making the bet that the global economy is actually stronger than expected and will resist a turndown or domestic recession. The bet is that the global economy has "decoupled" from the domestic economy to some measure.

Dry Ships

Click here for larger image.

The leadership stock in the dry shipping sector is DryShips (DRYS - commentary - Cramer's Take). DryShips operates most of its ships without long-term contracts and the company's earnings are dependent on the rise and fall of the Baltic Dry Index. The stock has recently pulled back and diverged from the Baltic Index. We see this as an opportunity to get long this name. The stock has broken the downtrend channel started in November and we believe DRYS is trying to "weave" some sort of bottom formation.

Trader can but the pullback here and use the $60 level as a stop loss point. If the Baltic Dry Index takes a sharp turn lower and DRYS breaks $60 traders should step clear of this trade. If DryShips can break out over $90 look for a new primary uptrend to develop from that level.

---

At the time of publication, John Hughes and Scott Maragioglio had no positions in the stocks mentioned. Hughes and Maragioglio co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indices and sectors. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion. Maragioglio is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Maragioglio has also served on the board of directors of the AAPTA.