Baltic Dry Index Signals an Economic Decline

As much as I like the way the economy and market have behaved the past six months, there is an ominous signal on the horizon that has a very good track record, the Baltic Dry Index, and for good reasons. The BDI is a daily survey of demand for shipping of dry goods, which is everything not a liquid (crude oil primarily), shipped in bulk. All container traffic are measured by an alternate index called HARP. But building materials such as timber or scrap steel, are considered "dry goods" and are a good indicator of economic activity. So, when demand is high for a given supply of ships, the price soars.

This has proven a very good leading indicator for the economy which will show the effect of those material inputs a few months hence. But when demand turns soft and there is less need for shipping to move bulk products around the world, the price drops. Price is very inelastic in respect to demand and the supply of ships takes time to alter. So, for a given short range of time, less than one year, it is hard to find a better indicator of near future economic activity and resultant equity market prices.

So what is the BDI saying to us today? After a very nice bounce off a bottom made in November 2008, it turned down in June. If this indicator leads the market by 3-4 months, then the economy will start showing this slump in demand by November at the latest. So, this is a reason I am very cautious on the near term for the stock markets. Even though there seem to be few barriers to a higher market today, we are not yet seeing the drop in demand for raw materials. This drop will be reflected in the stock markets soon.

And what does the drop in the BDI tell us about economic activity in China? This is a way to validate what is said about the miracle of the Chinese economy. If the BDI is dropping, then so are Chinese imports of bulk materials required for infrastructure.

Why economists and stock markets read it

The Baltic Dry Index is a daily average of prices to ship raw materials. It represents the cost paid by an end customer to have a shipping company transport raw materials across seas on the Baltic Exchange, the global marketplace for brokering shipping contracts. The index is quoted every working day at 1300 London time.

The Baltic canvasses brokers around the world and asks how much it would cost to book various cargoes of raw materials on various routes (e.g. 100,000 tons of iron ore from San Francisco to Hong Kong, or 1,000,000 metric tons of rice from Bangkok to Tokyo).

The index is made up of an average of the Baltic Supramax, Panamax, and Capesize indices. These indices are based on professional assessments made by a panel of international shipbroking companies.

The BDI factors in the four different sizes of oceangoing dry bulk transport vessels:

The BDI is based on US dollars, so may also be influenced by changes in the value of the US dollar.

The index can be accessed on a subscription basis directly from the Baltic Exchange as well as from major financial information and news services such as Thomson Reuters and Bloomberg L.P..

Most directly, the index measures the demand for shipping capacity versus the supply of dry bulk carriers. The demand for shipping varies with the amount of cargo that is being traded or moved in various markets (supply and demand).

The supply of cargo ships is generally both tight and inelastic — it takes two years to build a new ship, and ships are too expensive to take out of circulation the way airlines park unneeded jets in the Arizona desert. So marginal increases in demand can push the index higher quickly, and marginal demand decreases can cause the index to fall rapidly. e.g. "if you have 100 ships competing for 99 cargoes, rates go down, whereas if you've 99 ships competing for 100 cargoes, rates go up. in other words, small fleet changes and logistical matters can crash rates..." The index indirectly measures global supply and demand for the commodities shipped aboard dry bulk carriers, such as building materials, coal, crude oil, metallic ores, and grains.

Because dry bulk primarily consists of materials that function as raw material inputs to the production of intermediate or finished goods, such as concrete, electricity, steel, and food, the index is also seen as an efficient economic indicator of future economic growth and production. The BDI is termed a leading economic indicator because it predicts future economic activity.

Because it provides "an assessment of the price of moving the major raw materials by sea," according to The Baltic, "... it provides both a rare window into the highly opaque and diffuse shipping market and an accurate barometer of the volume of global trade -- devoid of political and other agenda concerns."

Another index, the HARPEX, focuses on containers freight. It provides an insight on the transport of a much wider base of commercial goods than commodities alone.

Other leading economic indicators — which serve as the foundation of important political and economic decisions - are often massaged to serve narrow interests, and subjected to adjustments or revisions. Payroll or employment numbers are often estimates; consumer confidence appears to measure nothing more than sentiment, often with no link to actual consumer behavior; gross national product figures are consistently revised, and so forth. Unlike stock and bond markets, the BDI "is totally devoid of speculative content," says Howard Simons, an economist and columnist at TheStreet.com. "People don't book freighters unless they have cargo to move."

Disclosure: No Positions

Comments

[Alphameister:]

I suspect you are making too much of the recent decline by the BDI. The correlation between the BDI and economic activity is strongest at major turning points such as last November to March; otherwise, fluctuations in the BDI have much less significance. The exponential rate at which the index climbed from March to June was unsustainable and influenced by a surge of commodity stockpiling in China. As widely reported, there was a significant idling of ships in the face of a dramatic decline in trade, and it does not take two years to bring an idled ship back into the marketplace. There have also been new ships reaching or nearing completion because of orders placed when the BDI was soaring to new highs two years ago. So some part of the recent decline reflects increased capacity. Measured from its lows, the BDI is still up dramatically. I doubt very much that you'll see the BDI making new lows in the foreseeable future.

Sep 11 08:38 AM

[conceptwizard:]

In order for the BDI not to get to new lows something has to fill these ships. China is all but done stockpiling and America, Germany, Canada and the UK have lost their consumers, especially in the US. So where do you get the demand for excess product outside the normal usage?

Sep 11 09:03 AM

[ari5000:]

global economy still high on stimulus from U.S. / China...

markets will eventually be fully priced... and stimulus will run out... markets should go full out gangbusters and then crash dramatically... just a matter of getting out at the top and not shorting too early (for those who short).

As debt creation is the only driver of the U.S. economy -- this is pretty much the name of the game -- bubble / bust / reflate -- this bubble we're in now may be the strongest and fastest -- certainly faster than the 'net bubble in my opinion.

Ride til she dies.

Sep 11 09:10 AM

[ed233:]

Certainly the slow down in the BDI is just another factor signaling caution going forward. This article certainly points that out. Excluding commodities there is practically nothing left to make a significant move forward unless someone is crazy enough to go into the financial sector. That sector has perhaps made the most significant move in the S&P. Precious metals look good as long as the dollar continues to fall. I don't see industrials or technology making significant moves from here. But of course, I was wrong predicting a correction a few months ago. Anyway, I'm very cautious from here on. Thanks for publishing your obverations. LOL Looking after your money.

Sep 13 07:20 PM