Slippery when BWET

This ETF is up 152% YTD, but is it going to be smooth sailing from here?

I’m not really a technical trader. I don’t even know how to chart, but I can read them.

When I’m looking for something new, I tend to expand my search patterns. I open the aperture on my scans and occasionally find something interesting that becomes a material change in my portfolio for years. I felt that way when I found sector ETFs in the early 2000s. Again, when I became a fulltime volatility trader.

A couple of days ago, I stumbled on the Breakwave Tanker Shipping ETF (BWET). The chart is a little obscene. In fact, if you didn’t know it was related to oceanic shipping, you might think it was some meme stock from WallStreetBets. We are seven weeks into the year and its averaging more than 20% a week.

When compared to my portfolio, its almost offensive to me. Its going up, up, up, like the Demon Hunters. Persistently, with seemingly no end in sight. So I bought some. A tiny amount, but I felt that I had to. I may even buy more.

But that’s not why we are here.

No, really. It might be.

I love income trades. I love vertical growth in assets where I stay too long and lament the loss of intentionally falling to FOMO and losing 10% - 30% from the top. The problem is that I have seen this trade before. Shipping is a bit of a boom and bust, cyclical trade for me, so I felt like I needed to check the data (something I am good at) and try to confirm some of my theories before I get all BWET.

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Run it back

If we look back a few years to the pandemic, we see that the shipping industry went nuts. We had huge demand and then crickets when everything shut down. For the boats, this was actually good in the beginning. When the boats were full and stuck offshore, the owners were still getting paid. Every day. Until they got into port, unloaded and then had no more inventory to pick up. Oil demand was shot. Regular materials weren’t going anywhere across long trade routes. It was a disaster.

In fact, if you look at charts from the period, you see a gorgeous run and then breakneck fall. This is what I am worried about now.

The conditions are wildly different, which means we have to explore the dynamics of the industry and what drives the ups and downs. Particularly, the rocket ship of today.

To put things in perspective, lets look at a couple of leaders in shipping. Frontline (FRO), DHT Holdings (DHT), and Scorpio Tankers (STNG). They are up 59%, 43%, and 41% respectively YTD. Sounds like we should all dive into shipping right?

Well, not so fast. Between BWET, which trades futures on the value of the routes (don’t ‘@’ me, I’m simplifying here), and the owners of the steel, its a banner year. So what is driving all of this?

There are many factors but lets start with the primary twins. Chaos and availability in the form of global dysfunction and a fragmented market for available steel.

• Geopolitical instability - The US has complicated things everywhere. From South America to the Middle East. Sanctions against everyone. Tariffs for one and all. This has driven long-haul boats to longer-haul routes, specifically in the Middle East where boats are skipping the canal and going all the way south and around the African continent, adding weeks and fees to their journeys. As long as we have crazy, we have longer shipping times and less available steel to ship.

• Boats - It isn’t just longer routes taking boats off the availability list. Global sanctions have taken boats out of compliance and forced them into a dark fleet running routes between nations of the naughty list.

The results coming from these two factors translate into very high, and increasingly higher fees for boats. This results in both massive gains for the owners and high prices. In some cases in the market, high dividends, driving income chasers to pump values even more. This is where I’m building my case for the big stop sign.

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Puts?

Going back to my boom-bust scenario. I feel like we see this time and again. Some set of economic factors drive up fees, there is a shortage of steel, the owners build, new tonnage comes online, the market crashes, some consolidation occurs, rinse and repeat.

Enter the now.

We are in the owners build phase. There are an estimated 419 new tankers hitting the water this year. We don’t know the split on flagging and legit verses dark fleet ships but we do know that is a lot of capacity coming online. We also know, if history is an example, that shipbuilding is usually a late cycle signal. Building ships into demand isn’t like a CPG company spinning up capacity to put out new widgets. The ships take a long time to build. The compression in capacity against high demand isn’t static, but even if we assume that it is, we suddenly have a massive amount of steel competing for all this cargo. I don’t think I need to tell you what that will do to fees, but its not bullish.

Currently fees per day are driven by “the long way around” Africa, fragmentation from the dark fleet, and availability. Just taking care of the last with more boats will seriously put fees to the downside. So what about the rest?

Simple: When geopolitical tensions normalize, which they will, fees will fall. When some of the sanctions and policy issues normalize, which some will, fees will fall.

To recap: The frothy market is being driven up by supply constrains on boats and long product delivery times. None of which are permanent or hard to solve. Trump could literally wake up tomorrow and impact the whole thing.

Any, or all of these things will create an air pocket which will translate to a gap down. Likely a big one.

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What’s it mean for BWET and the industry players?

Nothing good. I’m not a short seller and this isn’t a short briefing. It is talking through how I’m talking myself out of the trade, or at least building a watch list of indicators that help me know when to get out before I overstay my welcome.

BWET is the most susceptible to market factors. It carries a 3.5% expense ratio drag, so when the market starts to turn, its going to turn quickly. There are likely a lot of profit takers lining up to leave as soon as BWET is listed on SeekingAlpha, the Fool, or god forbid, Cramer. BWET is built for market dysfunction and disruption. Once the indicators show that things are calming, its time to go.

Some of the things I have targeted to watch include the fee rates for charters. VLCC, Suezmax, and Aframax. They are all inflated, big time. BWET trades futures on these routes and when they turn so should it.

You can find these at https://fearnpulse.com/ - look for this:

Fee rates, plus how many new boats have been contracted and the available population. Increasing fees are good. Increasing boats online, also good. Fewer boats waiting, wonderful. This trade looks amazing… for now.

Once these dynamics change, BWET and the industry players (like FRO, DHT, and STNG) should have a very tough time staying afloat.

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End note

I’m not going to explain FRO, DHT, and STNG, but before I go make some Sunday Sauce, I want to explain a bit about BWET, since this is what I’m on about and started today’s rant.

The BWET ETF tracks tanker freight futures, not the companies. Roughly 90% is attached to the TD3C transit route from the Middle East to China. The rest is TD20, the route from West Africa to Europe. The route fees and details are published daily in the Baltic Exchange.

BWET is near-dated by design, holding one to three month maturity contracts, continuously rolling them forward. Its a total panic trade. They thrive on volatility and die on calm. This is why its been killing it since last year. It moves because the market needs boats. When this market dynamic shifts from urgent need to a delayed ordering window where fees fall, less contracts are executed or for cheaper dollars, and more capacity is available, its not going to stay up for long.

I think this last paragraph explains why all this was so interesting to me. I’m a volatility trader. I am looking for things that trade like I do. When it hits the fan, this thing cooks. When the days look like smooth sailing, its cooked.

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Thanks for reading folks. Some days, I just share these thoughts in a private discord we kick about in, others I really want to think out loud.