By Tim Seymour
After a harrowing two-month plunge, the Baltic Dry index of shipping costs has finally rounded a bottom. The question is whether this is more than a brief respite for this key indicator of the health of global commodity markets -- everything from grain to iron ore.
Clearly the shipping trade needs work, with the BDI plunging a full 70% from its recent mid-October peak of 2,173 to an all-time low of 647 on February 3. At those levels, we were well below the depths of the 2008 economic meltdown, which was itself the worst time for shipping prices in recent memory.
But does this venerable index reflect a worse economic environment than at any other time since it was created 26 years ago? Not really.
In the past, BDI was seen as a great leading indicator of demand for commodities. But now, while the index has plunged, demand for bulk carriers remains as robust as it was. The shipping magnates expect global volume to increase 3% this year, now that Chinese consumers have come back from the long new year break and started buying metal and other raw materials again.
The problem is that supply is still spiraling out of control. Tonnage on the water is set to expand by 14% this year.
That much more supply on the market is bound to depress costs without indicating anything whatsoever about demand.
When the index surges, it is still a decent sign that demand for raw materials is accelerating. Suddenly everybody in Asia decides to replenish their warehouses of copper (NYSEARCA:JJC) or the iron ore produced by Rio Tinto (NYSE:RIO), Vale (NYSE:VALE) and BHP Billiton (NYSE:BHP), and the shipping lines ratchet up their rates to meet the demand -- and the index goes up.
In fact, these inflection points are where the BDI sees most of its upside, since commodity buyers who need to increase their intake fast do not have the luxury of haggling over long-term contracts, so they end up paying steep spot rates instead.
But when the BDI sinks, it means the market has stabilized. Most of the activity reverts to long-term contracts, fewer buyers are forced to buy space on the spot market and net pricing declines.
As such, the recent plunge in the BDI does not represent a plunge in the amount of material shipped so much as a normalization after the fairly dramatic struggle for cargo hold space we saw late last summer.
If anything, SEA now seems better correlated with commodity prices now, as you can see from a look at a metal ETF like DBB. The danger here is that SEA has not been any kind of leading indicator, as you might expect from the BDI's reputation. As the metal ETF rises, SEA rises too. And vice versa. That tells us a lot about current market psychology, but gives us few cues on where commodity prices are going next.