Despite Zero Hedge Having Kittens Don't Worry About The Baltic Dry Index Plunge

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Includes: SEA
by: Tim Worstall

Summary

BDI is a measure of the price of shipping bulk cargoes, not the volume being shipped.

BDI is thus influenced by the supply of dry cargo capable ships, not just demand for them.

The supply has recently risen, as it has for container shipping.

analysis Zero Hedge is most amusingly going into hysterics about the plunge in the Baltic Dry Index (BDI) the bellwether for the price of shipping bulk cargoes around the world. The problem with this, most enjoyable though it is seeing them work themselves up into a lather over it, is that they're ignoring the fact that both supply and also demand influence the price of things.

That means that we cannot reason purely from a price change: we cannot say that because the price of something has fallen therefore demand must have also fallen. Equally, we cannot look at any price change and then say, with confidence, that it must be because either supply or demand have changed. It must, of course, be one of the two but we can't say which without further examination.

And that is their error:

The continued collapse of The Baltic Dry Index remains ignored by most - besides we still have Netflix, right? But, as Dollar Vigilante's Jeff Berwick details, it appears the worldwide 'real' economy has ground to a halt!! Last week, I received news from a contact who is friends with one of the biggest billionaire shipping families in the world. He told me they had no ships at sea right now, because operating them meant running at a loss. This weekend, reports are circulating saying much the same thing: The North Atlantic has little or no cargo ships traveling in its waters. Instead, they are anchored. Unmoving. Empty.

That larger reporting there is simply untrue. No, it just isn't true, as they claim, that there's no shipping going on. So, what is it that has caused the Baltic Dry, that price index, to fall?

I explained the very similar happening in container rates here at Seeking Alpha.

Looks bad, and the company has decided to fire 4,000 people and shutter some routes. But is this actually a fall in underlying trade? No, it isn't:

Analysts estimate the industry suffers from up to 30% overcapacity on some of the busiest ocean trade routes. Container ships move more than 95% of the world's manufactured goods. New ship deliveries will boost capacity by 1.7 million containers, or 8.2%, while demand should top out at 2% this year, the lowest since 2009, estimates Jonathan Roach, a container analyst at London-based Braemar ACM Shipbroking.

What we've got is supply expanding faster than demand, not an actual fall in demand. It's similar to the iron ore story: it's not so much that the world is using (much) less iron ore, it's that large new supplies of very cheap material are coming to market.

And so it is in the other part of the global shipping industry, that for dry cargoes:

A longer term factor is that it takes more than two years to build ships, whereas demand can change very quickly. The world is suffering from a huge oversupply of mega ships that have been built to feed China's demand for commodities. Vale the biggest iron ore miner in the world has built a fleet of 35 massive iron ore carriers, to ferry iron from Brazil to China.

People expected China to keep growing faster than it has been most recently. They therefore overbuilt their fleets. Thus the fall in freight rates: not a sudden collapse in demand but an increase in supply for demand that never did materialize.

Is economic growth slowing? Most assuredly it is, yes. Is global trade growing less swiftly than it used to? Sure. Have either the global economy or global trade come to a shuddering halt?

Nope: we're seeing prices collapse as new supply, capacity designed for demand that hasn't turned up, reaches the market. This most certainly doesn't mean that everything is peachy but it's not time for the shotguns and the canned beans just yet.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.