Baltic Dry Freight Index Indicates Impending Recession

Every once in a while, an economic term or indicator that was previously not widely followed finds its way into the mainstream financial conversation. Before the Fall, if you had asked nine out of ten people what the TED Spread was, we don't even want to guess what the typical response would have been. Once the credit crisis accelerated though, this was the indicator that everyone was watching to guage the stress in the system. Now that the TED Spread is back to approaching more normal levels, we suspect that it will go the way of Spuds MacKenzie.

One indicator that seems likely to replace the TED Spread as the indicator du jour is the Baltic Dry Freight Index. While many readers may be familiar with the term, for those who aren't, the Index measures the cost of moving raw materials by sea in container ships. Many economists consider the index to be a good leading indicator of economic activity, because if not as many people are looking to move cargo, ships will be in less demand, causing a drop in the price that shippers can charge.

For many economists, recent declines in the Baltic Index have reinforced views that the economy is not only weakening, but heading into recession. While the 37% decline since mid-November makes good headlines, some perspective is needed. Using data going back to 1985, there have been nine other periods where the Baltic Index declined by 35% or more. Over the same period, the economy has slipped into recession only twice. So while the Baltic Index typically declines leading up to or during recessions, declines in the index do not necessarily mean that a recession is on the horizon.

The chart below shows the performance of the Baltic Index since 1985. At first glance, the chart is reminiscent of the Nasdaq in 2000 or a homebuilder stock in 2005. Whether or not the Baltic Index is a bubble that has now burst is up for debate, but we would note that part of this sharp increase can be linked to China's entrance into the WTO on December 11, 2001 (red line).

click to enlarge

Comments

[User 141327:]

the baltic dry freight index has nothing to do with container ships. It deals with the cost to move dry, bulk freight (not in containers)

2008 Jan 17 01:44 PM

[haydete:]

Yes, BDI is the cost (not quantity, share price, or availability) of shipping dry goods such as ores, grains, etc. Perhaps it would be more indicative to see if the projected shipping volumes are also down, not the price of shipping them. Business (the Chinese?) will always look to chop the expense from their supply chain, and this is one of them.

2008 Jan 17 02:14 PM

[ShipKnowledge:]

Firstly let me point out that the BDI is NOT a measure of container shipping rates. The BDI is a composite of the Capesize, Panamax and Handymax Indices. These ships are used for the transportation of bulk dry commodities such as coal, iron ore, wheat, soyabeans and steel products.
There is some merit in considering that the BDI decline could indicate a slow down in global industrial production but i dont think that a one month decline from historically unheard of levels should be considered a good leading indicator. The BDI is still very much in a long term bullish trend.

2008 Jan 17 04:25 PM

[User 141447:]

This is an over-reaction to the economic downturn. China and India (and the rest of Asia for that matter) aren't going to quit importing dry commodities. The iron ore has to get from Brazil to China somehow. The majority of shipping stocks are selling at very reasonable pe multiples. Take a look at EXM - you buy it now and you will be happy by the end of the year.

2008 Jan 17 05:39 PM

[haydete:]

Given that part of the run-up in the BDI was due to congestion at one Australian port, here's an article explaining why many ships will be "out of work" for a while. It helps explain the see-saw in price, maybe.

From Mineweb
www.mineweb.com/minewe...

In the meantime, Forbes reported Monday, that "with an iron ore port closing outside of Rio de Janeiro and increasing uncertainty around upcoming iron ore negotiations, the demand for dry bulk ships, as well a charter rates, have fallen." Vale announced last week that the Itagui maritime terminal in Rio de Janeiro would be closed for a few weeks for repairs after an accident last month damaged the facility.

Jefferies & Co. analyst Douglas J. Mavrinac told Forbes that "by not having the volumes on the water it has caused the spot price of iron ore to increase and created a tighter market which benefits the miners when it comes to negotiation." Maximum Group analyst Charles Rupinski said a lot of ships aren't getting hired because of the upcoming iron ore negotiations because companies want to know how much iron ore will cost before hiring a ship. If prices increase with iron ore comprising 25% of all dry bulk trade, Rupinski forecast that more ships will be hired.

2008 Jan 17 05:53 PM

[Kunst:]

I have been short EXM since 12/3/07. My puts are up 164%. All of what is said above is true, but short-term, decreased economic activity is going to continue downward pressure. On the upswing, some months from now, this area is a big winner. But not today.

2008 Jan 18 12:32 AM

[User 101257:]

I have been involved in the financial side of the shipping market for 30 years. I have been predicting the fall in this index for about 2 months, but it has nothing to do with container ships-- only dry bulk. These ships have been grossly overrpriced-- sold and purchased at historical highs only justified by a temporary blip in the spot market. I have just graphed the baltic index over the free fall of dry bulk stocks , which doubled in the fall of 2008 and have fallen back to those levels in less than 2 months. almost 30 % of the world"s shipping supply is on order , coming out of Asian shipyards--all fueled by greedy owners, excessive liquidity in the public equity markets and cheap debt--- all of this is about to end and it will be ugly. I would love to speak to Cramer about this on his show.

2008 Jan 18 10:19 PM

[User 101257:]

Sorry , I just sent you the above email and need to correct that the doubling of the dry bulk stocks was in the fall of 2007 ( got a little ahead of myself) . Happy to forward the graph if useful

2008 Jan 18 10:21 PM

[turnmore:]

User 101257,

At what level will the BDI reach equilibrium?
When will this level be reached, and what will be the corresponding average PE of a dry bulk shipping company stock?

Educated guesswork is welcome,

Thanks

2008 Jan 21 05:29 PM

[LBX:]

I don't think people get it.

The crash is caused by a massive decline in Chinese domestic AND international demand for manufactures.

Chinese power generation (read coal) is up a miserly 3% in Sept. YOY. That is blamed on Olympics, etc. but it is far too big a drop to be just blamed on that --- Chinese businesses and consumers are cutting back consumption of electricity big time. It was growing at 11-15% a year since 2002.

There is a huge glut of real estate (residential, commercial, industrial) in China that is causing construction to grind to a halt (unless it is reconstruction in Szechuan). The core issue for residential is that most of the apartments in big cities are way beyond the local populations income to own, so they were bought as speculative investments who have now disappeared with prices imploding. Industrial real estate --- tons of empty factories as the export business caves.

This means lots less need for iron ore (rebar, structural steel, etc.), copper, aluminum, (wiring), cement (clinker), etc. Prices of steel on the Chinese market is caving, as is the price of copper, etc.

China is not going to stop importing iron ore, but they sure can halt demand growth for a while.

The bottom line is that shipping rates will fall through the floor now that capacity has overwhelmed demand (which caved).

2008 Oct 16 01:34 AM

[D Brisco:]

Does anyone know the current Atlantic panamax rate for Virginia to Rotterdam, or from S Africa to Rotterdam? In May they were above $50/t, and by December had dropped to under $10/t, just wondering how far they've fallen since...

Jan 15 01:29 PM