BDI Signals Slack Demand for Raw Materials

Last Friday, the Baltic Dry Index ended the week on an up note at 2,183, finally. It was the first up day in 10 sessions. In fact, the 7.3% decline for the week was the ninth weekly drop in ten weeks. In the last three months, while global equity markets have rallied on increasing expectations of global recovery, the Baltic Dry Index (BDI) has quietly, steadily declined. Since its peak this year on June 3, 2009 at 4,291, it has declined 49%. The S&P 500 Index in the United States, for example, has increased 13% in the same time frame.

This is important because unlike asset markets, this Baltic Dry Index measures economic activity that is supposed to be at the heart of the economic recovery. The index reflects the demand for, among other things, transporting iron ore and coal from Australia to China that is a direct input to Chinese industrial production topics I have discussed in past articles. Much of justification for a recovery, particularly in commodities prices, is linked to Asia-related trade and consumption. Yet if this trade and consumption was so robust the BDI should be headed up (or at least holding flat) rather than in retreat.

Baltic Dry Index has been in a steady slide since Chinese stockpiling peaked. As is common knowledge now, the government of China launched a massive fiscal stimulus program early this year that included stockpiling of raw materials and metals. This program was a gift to miners such as BHP Billiton (BHP) and Rio Tinto (RTP) by putting a floor under and even driving up prices on key commodities such as iron ore, coal, aluminum, and copper.

Much of the positive effect of this program has come and gone now. Chinese authorities have expressed concern about over-production of steel and cement. Setting aside last week’s drop in crude prices, commodities markets have been acting as though demand for raw materials remains robust. Through the period of Chinese stockpiling iron ore spot prices recovered from a low of $60/ton to almost $100/ton. Today they have dropped back to the mid 80s. This is in line with the iPath DJ AIG Industrial Metals ETN (JJN), up 51% year to date.

Commodities are trading as much as an asset class as material to be consumed. It is quite unclear what the future holds for the demand for materials like iron ore, aluminum or copper. There are bullish arguments to be made based on the industrial production that is recovering worldwide (albeit still at low levels) and mining production that has been shut in. There are also bearish arguments to make such as slack demand and robust production gains made during 2005 through 2008.

The chart above looks at the iPath ETN for industrial metals (JJN) in green against the backdrop of a key global equity market, the S&P500 (SPY) and the Baltic Dry Index over the last year. While one would expect prices of industrial materials would reflect industrial demand. Industrial production in the United States hit its bottom in June 2009 while Japan and Germany bottomed a few months prior to that. The steady march up in price of industrial metals from February to August appears more in line with an asset market than demand reflected in the BDI. However, the Baltic Dry Index, while imperfect, may today be a better reflection of commodities demand than prices themselves. To understand this it is best to explain what the index is and what it measures.

The Baltic Dry Index is calculated each day in London at the Baltic Exchange that specializes in ocean shipping of bulk materials. The exchange is privately held by its members and is over 250 years old. The exchange derives its name from the Virginia and Baltick coffee house where it originally met in the 18^th century. The Baltic Exchange specializes in bulk shipping of items such as metals, coal, iron ore, grains and steel. Excluded from this focus are container ships, car carriers and shippers of crude oil so it is important not to focus too exclusively on what the Baltic Dry Index can cover. Recently the Baltic Exchange has developed two indices (Baltic Dirty Tanker & Baltic Clean Tanker) to track prices of tankers of crude oil and another for the shipment of Liquefied Natural Gas. The Dry Index is Baltic’s specialty, though.

To calculate the BDI, the Baltic Exchange summarizes the average price of the contracts cleared on given day for four different categories: Capesize, Panamax, Supramax, and Handysize. These four categories represent the four categories (sizes) of dry bulk ships in use today.

Handysize and Supramax are the smallest, often used to transport grain and other foods to ports where facilities for larger ships are not available. Ships from each of these categories are also used to transport industrial materials such as scrap iron, concrete, and steel.

The Panamax category of ship derives its name from the fact that it is the largest class able to navigate the locks at the Panama Canal. It can carry grains and industrial materials similar to the smaller ships but also is pressed into service for coal and iron ore shipments.

The Capesize is too large for the Panama Canal and must circumnavigate the globe via the Cape of Good Hope (Africa) and Cape Horn (South America). While less versatile than the small ships it has become the workhorse for the iron ore and coal shipments, particularly those between Australia and China.

This year’s volatility in the Baltic Dry index has been driven by iron ore and coal shipments. The Baltic Index also publishes the four sub-indices from which its main index is derived. Since the beginning of the year, it has been the Baltic Capesize Index that has been the driving force behind the movement in the broader Dry Index. Earlier in the year anecdotes abounded of Capesize ships stacking up at Chinese ports waiting to offload shipments from Brazil and Australia. Such port congestion can lengthen the transport time and drive up daily spot rates for the vessels.

The Capesize Index spiked above 8,000 the day of June 3^rd, providing the high water mark for the year for this index and its parent, the BDI. The Capesize Index approached but did not reach 8,000 later that month. Since June, this sub-index has fallen by two-thirds, closing last week at 2,677, double from where it stood at the end of 2008.

The other three sub-indices have had a more muted effect on the Baltic Dry Index with the Panamax Index also benefiting from the China iron ore stockpiling effect. As the Supramax and Handysize indices are largely insulated from that stockpiling effect, they have marched steadily higher, likely based on the gradual return of global growth.

With the Baltic Dry Index hitting 5 month lows, the question is “Will the slide in the Baltic Dry Index continue?” I have no data with which to suggest a forecast but I do believe the BDI provides a better view of underlying global demand for raw materials than the prices of many commodities. My best guess is that the index will flatten out as it nears or drops below 2,000 (the BDI is at 2,183 as of Sept. 25, 2009) and move sideways for the rest of the year.

Today’s anecdotes are not of port congestion but of a “ghost fleet” of tankers floating empty off the coast of Singapore. Many shipping companies are still expecting delivery of new ships this year and next adding to capacity. A look at the most recent analyst presentation from bulk shippers Eagle Bulk Shipping (EGLE), Dryships (DRYS), Genco Shipping (GNK) and Navios Maritime (NM) is not reassuring. They point to the scrapping of older vessels (which is common in a downturn) as evidence capacity is coming in line. At the same time, they cite bullish stories of Chinese iron ore imports and steel production.

It is true that this phenomenon lifted shippers’ business in the first half of 2009 as it did in for miners BHP, Rio, and Brazil’s Vale (VALE). But given that we know this is a story of the past, we might just say, “that ship has sailed.” At least BHP and Rio have highlighted to their investors that the end of the stockpiling story, describing instead a murky near term outlook. For dry bulk shippers in the coming month there is more downside risk than upside potential.

Disclosure: No positions

Comments

[ramisle:]

Good job, you can get a view of the future of the BDI, it's the FFA's, forward freight agreements. Futures traded by the industry, often used as a hedge by the ship owners. They are headed down for awhile.
platou.com
The BDI shouldn't be used as a gage of economic activity, it was completely driven by China, and yet China cannot sustain the world's fleet by itself. It was wildly altered by the Iron Ore price negotiations between the Miners and CISA. The Chinese Iron and Steel Association, was warning that 60% of the Ore purchases were made by speculators, not steel makers, that were betting that there would be a rise in the price of ore. This led to the long lines tying up ships, and the fact that much more ore was being stockpiled than could be processed each month. The real demand would have left charter rates much lower. Like now.
And even now, if the GDP of the industrialized nations were to grow by 8%, the BDI will stay stagnant , because the fleet is expected to grow by 25% over the next two years. For those that hear about scrapping and cancellations, There are better sources of shipping news.
drewrys.co.uk
weberseas.com
brs-paris.com
cotzias.com
worldyards.com
lloydslist.com
fearnleys.com
nilimar.com

Sep 28 06:14 PM

[mkreisel:]

BDI seems to lead SPX by a couple of months during the last 12 months.

Sep 28 07:15 PM

[Ecomike:]

If you remove the Capex from the BDI, as it is mostly indicative of iron ore and coal demand in China, the BDI looks more like a slow steady climb all year which is more indicative of true demand IMHO. China ran up the Capex part of the BDI earlier this year stockpiling, then they shut off the orders when Rio POed the Chinese by doing an investment deal with BP, instead of China. I suspect China artificially pushed the Capex rates up earlier to stimulate the world economy, while stockpiling cheap materials, trading dollars for hard raw materials, and spiking the demand for Capex ships temporarily to slow the Capex ship order cancellation rate in Chinese ship yards, which use steel from coal and iron ore by the way. I am surprised no one has mentioned this in blogs before now. By the way did anyone notice that the Capex nose dived right after Rio cut the deal with BP instead of China? Hmmm! Seems to me the Capex ships were running from Rio to China, and back, and then just suddenly stopped.

Sep 29 12:49 AM

[parkwood:]

BDI couldn't be used as a gauge of economic activity? I don't think so. Actually it is a better gauge than SPX 500, although sometimes more bubbly driven by some specific events, but it more reflects china economy and remotely related to the US one. The demand of iron ores from China in the past years has brought the huge capacity of bulkers, if China stopped the purchasing, BDI would crash, plain and simple.

I have given out a lot of negativity when BDI was 4000 plus a few months ago, now it is around 2000, I am more cautious and temporarily have a neutral rating. There are still very bearish signals existing besides the order book numbers. China steel market prices are still sinking, although at a slower pace, the outputs of the mills are still at high level, they are not willing to cut, they are praying there has a better 4th quarter and wish other mill cut first, if they lost their all margins, they will. The ultimate reason of china huge ore import and high production this year is china's stimulus plan, unfortunately many projects will be finished later this year or next year, that means if there has no another stimulus plan, if the world and china economy don't have a strong recovery next year, the china steel market will have a much harder time, this hardship will transfer to bulker market as well.

But fundamentally there still have some favorable factors for BDI. China's domestic ore quality is deteriorating every year, they must import, sometimes even more if the spot market price is cheap, although you don't know when they will begin the restocking. China economy is still in a much better shape than the US one in the near future, and will benefit from US recovery. CISA is vowing to unified the import price next year to eradicate the speculation, I am not optimistic about their efforts, that is a big force in the volatility of BDI.

China will celebrate their sixtieth National Day this week and will have a long holiday week. Maybe you can have some idea of the BDI trend by watching their steel market performance after the long holiday vacation.

Sep 29 01:08 AM

[parkwood:]

Ecomike, that scenario is unreal. I don't think China is rigging the BDI now, on the contrary BDI is a useful tool for the miners like BHP sometimes, I know they can affect the shipping rate shortly between AUS and China if they place many orders in the spot market in a very short time. China is more often a victim of such volatility, because shipping fee is a serious part of their cost, compare to it, you know they had a strenuous war with miners just for a few dollars ore price difference, let alone last year BDI bull market has brought huge loss to their mills.

Sep 29 01:58 AM

[Ecomike:]

I am not sure but I think you two missed one of my points. I must have seen a hundred or more positions taken lately saying that the BDI is an excellent leading indicator of economic growth, but I think for now there is too much noise going on from new builds hitting the water, dropping the rates, and China buying excess material at low prices, and then cutting way back to live off the excess inventory while prices drop back down, for the BDI to be the world markets pre-indicator anymore. Hell, the last huge run up in CAPex rates, and thus most of the run up in the BDI earlier this year, had a lot more to do with just port congestion in China, and China restocking from their inventories from the September 08 to March 09 crash in imports.

All I am saying is people are reading way too much into the BDI numbers the days. If anything, just look at the recent numbers, and if anything one would conclude it is very volatile.

Sep 29 11:07 PM

[ramisle:]

parkwood, you just made the case where the BDI is not an ACCURATE gauge of economic activity.
"If China stopped purchasing, the BDI would crash, plain and simple".
Well, China didn't stop, they slowed slightly, and yet the BDI dropped by 50% from June highs.
What has changed? The imports of ore dropped only 10%. The imports of Coal increased in China and India. The production of steel products rose to a record in August. What has changed is the long lines of ships waiting to unload. There are fifty fewer Capes waiting to unload, increasing the supply of ships available.
After a flurry of activity that imported more ore than could be processed, the shipping normalized to an orderly schedule of delivery. Add to that the addition of more new ships and the BDI gives a false impression that things came to a screeching halt in China.
The fact that Vale has pretty much stopped leasing ships on spot, will have a huge impact on BDI. They signed long contracts with Japanese and Korean shippers, and most importantly, they bought 20 Capes and VLOC's, and have 12 VLOC's on order.

Oct 02 08:23 AM

[mattfinance:]

With regards to shipping news, don't forget capitallinkshipping.com

Oct 06 11:27 AM

[poor&unempl...:]

BDI is very much rigged index. There are no cleared contracts, which are audited by anyone.

There is something called related party transaction, in which charter rates are manupulated by the related parties. It is like father and son chartering the vessels to each other at $100,000 /day while there are 100 odd vessels willing do the business for $5000 /day or less. BDI includes these transactions to inflate the index.

Explain to me if I am wrong!

Oct 14 02:59 PM