All sophisticated markets move in cycles, and the Baltic Dry index (BDI) is no exception. Physical and futures markets are derived from each other, and all have one major connection, Human psychology.

The nature of markets is to move in waves, each of which represent the human behaviour of the market. The first stage of any market rally is that of accumulation, creating a market bottom and a subsequent move higher, this is followed by a rebalance in the form of a corrective move lower.

The second move up (the third wave) is usually the strongest wave, it is generally accompanied with strong fundamentals and optimism. This is the move where the general mass get involved, it has consistent strong up days, and nearly always the price exceeds that of the fundamental valuations. Again the market needs to rebalance, as market participants withdraw and lock in the profits they have made.

The final move up is fifth wave, this move is driven by fear and greed. These participants were not convinced that the original fundamentals were sound, and now find themselves compelled to buy as they don’t want to miss out. This final wave is where you see market professionals distribute their long positions onto the unsuspecting, before the market enters a longer and more sustained correction. Corrections typically retrace in three waves, known as A, B and C. With A, C being the two corrective moves down. Wave B being the infamous bear trap, where bullish participants still believe that there may be another move upward.

These cycles work in elements of degrees, the super cycle that we witnessed in the BDI prior to its crash in 2008 will have been a series of psychological cycles within each other. They are known as the Elliott Wave cycle, which became popular in the 1970’s after the publication of the Elliott Wave experience by Pretcher and Frost.

The Elliott Wave cycle is popular in commodity markets, as they cycle often fit in with the seasonality of natural cycles, like the one that is witnessed regularly within the BDI, driven by the Capesize sector, the largest of the bulkers within the BDI index.

The Current cycle within the BDI has seen accumulation between February and March, before entering into the second move up between May and July (leg 3). The corrective move that we are currently in is Leg 4, this means we are still waiting for the final wave upward move, which fits into the seasonal rally that is often associated with the final Quarter of the year.

What does this mean for 2016?

This leaves us with an interesting Scenario for 2016. If as expected wave 5 expires in Q4 (often in Dec, though occasionally in Jan), this means we enter into a corrective phase for Q1, and potentially the early part of Q2 (Q1 is historically the weakest Quarter in the shipping cycle) which would make sense. The bear trap would be in the middle part of the year (wave B) most probably between May and August, and market price would not be expected to exceed that of Q4 2015.

The final corrective wave would be leg C. Based on the cycle fitting in with the seasonality of a weak Q1 and a moderate summer, then Q4 (often the banker for ship owners) will almost certainly be negative rather than traditionally positive.

There is the possibility that there is a larger cycle at play on the monthly chart, that is linked to the four year business cycle, on this larger cycle you are about to start on leg 3. This would still point to a high Q4 and a corrective Q1, with the summer being the final rally (leg 5). Again, unfortunately this points to a negative Q4 of 2016.

Either way Q4 of 2016 (most likely from late August so part of Q3) is going to be a huge disappointment for the shipping community. The big question is, will the prices in the summer of 2016 surpass that of Q4 2015? Fundamentally that looks hard to imagine at this point, however the clue will be in the Q1 retracement. If that holds up higher than average, owners could have a cracking summer!!
Source: Freight Investor Services (http://freightinvestorservices.com/blog/the-psychological-cycle-of-freight-setting-the-tempo-for-2016/)