Commodities Will Pull Back Due to LoC Frozen

Just as the business world is dependent upon commercial paper as its life blood, the world of global trade depends on letters of credit (LOC). Without LOCs, the world of trade quickly freezes up. The lack of letters of credit, in which banks guarantee payment for merchandise, could become a "big issue" for world trade, according to Klaus Nyborg, Deputy Chief Executive Officer at Pacific Basin. Tighter credit has contributed to this year's 80 percent drop in the Baltic Dry Index, a measure of commodity-shipping costs, and further dropped 8.5 percent to 1,809 points yesterday, the lowest level since August 2005. Pacific Basin dropped 6.5 percent to HK$4.75 in Hong Kong and Precious Shipping declined 5.5 percent to 12.1 baht in Bangkok. About 90 percent of world trade moves by sea.

Chart Courtesy of The Financial Ninja
Entirely Banks in the world have curbed lending because of increased concerns about getting their money back. Shipowners are already struggling to obtain funding for new vessels. Precious Shipping took as long as 15 months to secure financing for 18 vessels it has on order.

From The Financial Post of Canada - Grain piles up in ports, October 8, 2008 :

There are all kinds of stuff stacked up on docks right now that can't be shipped because people can't get letters of credit,' said Bill Gary, president of Commodity Information Systems in Oklahoma City. 'The problem is not demand, and it's not supply because we have plenty of supply. It's finding anyone who can come up with the credit to buy.'

So far the problem is mostly being felt in U.S. and South American ports, but observers say it is only a matter of time before it hits Canada. 'We've got a nightmare in front of us and a lot of people are concerned it's going to get a lot worse,' said Anthony Temple, a grain marketing expert based in Vancouver.

Access to credit is key to the survival of maritime trade and insiders now say the supply is being severely restricted. More than 90% of the world's trade by volume goes by ship. "The credit crisis has made banks nervous and the last thing on their minds is making fresh loans," Omar Nokta

From Naked Capitalism - International Trade Seizing Up Due to Banking Crisis (Updated), October 10, 2008 12:12 am:

"At the end of the day, if every counterparty is bad then you don't have a market and you don't have an economy. I spoke to another friend of mine this afternoon, whose father has been in the shipping business forever. Pristine credit rating, rock solid balance sheet. He says if he takes his BNP Paribas letter of credit to Citi today for short term funding for his vessels, they won't give it to him. That means he can't ship goods, which means that within the next 2 weeks, physical shortages of commodities begins to show up. THE CENTRAL BANKS CAN'T LET THAT HAPPEN OR WE HAVE NO ECONOMY, LET ALONE A CREDIT SYSTEM."

As result of Letter of Credit Frozen is shipping for coal, iron ore and other commodities will fall because banks are guaranteeing fewer loads. Accordingly, prices for most commodities will be elevated. Moreover, there is a very real risk that various economies will start to face stresses in this time of "Just In Time Delivery" as very small stock piles vital commodities quickly get vacuumed up by normal industrial demand. The iShares S&P GSCI Commodity-Indexed Trust (GSG) is recommended to buy as hedging to being elevated commodity prices.

But the pulling back in commodity prices might be just for a short live as global governments act intensively to ease credit frozen.

Sources :

1. The Financial Ninja:Credit Crunch: Baltic Dry, October 15, 2008 07:51 am
2. ETF Trends: Commodity ETFs Go for a Ride, October 15, 2008 at 12:00 pm
3. Safe Haven: Baltic Dry Shipping Collapses, October 15, 2008

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