Rethinking the Baltic Dry Index

Includes: BDG, CRB, SEA
by: Hard Assets Investor

By Julian Murdoch

Leading Or Lagging Indicator

The Baltic Dry Index, or BDI, is an index that tracks a blending of rates to ship dry goods - basic raw materials like iron, coal and grains - on three different-sized boats on the four main shipping routes.

Conventional wisdom - or perhaps just tradition - has analysts looking at the BDI as a leading indicator of how commodities and the global economy will perform. The old adage is that no one hires a ship unless they have something to transport, and if people are transporting things, that means they're buying and selling.

The idea does make some sense. But lately, the BDI's ups and downs have looked less like Harry Potter's Marauder's Map and more like the meanderings of a drunk driver.

Maybe, though, the BDI never has been a crystal ball. To dig a bit deeper, I caught up with Paul Hickey from Bespoke Investment Group, who's written regularly about the usefulness of the BDI as a technical indicator.

"You'd rather see it rising than falling," explains Hickey. "But it hasn't always been a perfectly reliable indicator to watch."

Is That An EKG?

Lately, if the BDI were a roller coaster, it would be an E-ticket ride. In the past six years, wild swings have been the norm, rather than the exception:

This BDI chart from Allied Shipbroking's weekly sales and purchase report starts back in 1985 and goes to August 17, 2009. It illustrates that the BDI has always been volatile, but prior to 2003, that volatility moved within a narrow band. Only since October 2003 have we started to see extreme swings - some as wide as 100% or more.

The past three months have been no exception:

Since May 20, 2009, the BDI has been up 60%, only to drop all the way back down - and then some.

Most recently, the 25% drop between July 29 and August 12 has particularly troubled analysts. "The decline in the BDI is certainly somewhat of a negative for the whole idea of a global economic recovery," says Hickey.

But looking at the BDI on its own doesn't really tell you much. It's just a number without context.

BDI vs. The World

"If we look back in the spring," Hickey says, "the index peaked about March 9 - right when the equity market bottomed - and declined through mid-April. The strongest part of the equity rally happened at the same time the Baltic Dry Index was declining."

Not exactly what conventional wisdom would lead you to expect, if you thought the BDI was a true crystal ball.

The picture looks similar when you compare the index with various commodity indices:

From March to April, when the BDI is falling, the best performer is Power Shares DB Base Metals Long ETN (NYSE Arca: BDG). The pattern repeats itself at the end of July until the present: While the BDI takes its 25% plunge, BDG remains comparatively steady.

Some crystal ball, at least in real time. The BDI's plummet seems not to have presaged much of anything.

The Reuters/Jefferies CRB Index (Pending:CRB) shows a similar, though less remarkable, trend unrelated to the BDI's wild swings. Considering the CRB is a broad-based commodity index comprising mainly things not transported in dry bulk ships, it's not too surprising that it would be insulated from the BDI's movements.

How about when you compare the BDI to the thing it should be most closely related to: the shipping companies themselves?

The Claymore/Delta Global Shipping Index ETF (NYSE Arca: SEA) began trading just about a year ago. Since then, SEA has had a rough time - losing over 50% - and mostly following the trend of the BDI. It's tempting to look at last fall and create a causal story.

But when you compare BDI, SEA and the S&P 500, you find that SEA more closely relates to equities than the BDI.

Put another way: Everything was going to hell in a handbasket last fall, and shipping was just a wee bit worse than the market as a whole. Over time, the correlation between SEA and the S&P 500 is about .93.

One major reason for this - as you may remember from "Digging Into Shipping" - is that most companies have moved away from spot pricing and have their ships on time charters. That means even most shipping companies' fortunes aren't closely tied to the BDI, although it still may influence share price in the market, as a measure of the health of the industry.

Lead, Follow Or Get Out Of The Way?

So is the BDI a leading or lagging indicator? Unfortunately, the answer seems to be: It depends.

Let's take the long view:

Looking back to when all this volatility started in 2003, we can see why some consider the BDI a leading indicator. On average, as the BDI climbed, so did things like the DJ World Basic Materials Index, which contains all the precursors of industrial production. Both sharply fell during the Great Commodities Crash of 2008, and have been recovering since. But the connection is very far from perfect, or perhaps even useful; in several cases, the two move in opposition (for instance, mid-2006, and now).

The case for the BDI is even weaker when you look at CRB and BDI, where only the early 2008 peak and the subsequent Great Commodities Crash of 2008 periods clearly correlate.

And the case completely falls apart if you look at the most recent decline in the BDI:

Is the BDI still relevant as an economic indicator? I guess the answer is: BDI works when looking at long-term trends and strategy. But for current trends, other factors are more relevant.

So for investors looking for a crystal ball in the BDI, be careful: It's cracked.

Charts courtesy