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BDI - Big Drop Indeed - Currently Down 94% From Peak

UPDATE: Jan. 31 - How ironic is it, that no sooner had this piece been published yesterday, this article appears on Zero Hedge today?
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ORIGINAL ARTICLE:

Every once in a while the Baltic Dry Index is brought to the forefront for discussion. This is one of those times and I guess for good reason since it has dropped 53% this month alone. Are you kiddin' me? Wow! This shipping index deserves another look to be sure.

I personally haven't used the $BDI for the purposes of trying to gain any timing advice regarding the broader stock markets in the past 5 years at least. I'll explain why a bit later on. The theory is that since it's a kind of transportation index it gives an indication of the health of the global economy. So in that respect it's different from the Transportation Index ($TRAN) or statistics on rail traffic which are both based on the US economy alone. By far, the $TRAN and rail traffic studies offer much better guidance on the timing aspects for the North American markets. Further, the $BDI is a measure of the prices charged for carrying ship cargo that, well... that is not liquid. In other words, basically it's a measure of prices charged for the shipping of dry goods such as coal, wheat, lumber, goats, automobiles, steel, goats, textiles, electronic goods, goats, furniture, etc. Did I mention goats? But it doesn't include oil. And neither does the CPI data and we know how accurate that ridiculous measure is. But for the purposes of measuring the health of the global interactive economy, the $BDI does offer a general clue. Currently, the Baltic Dry Index has pulled back a bit from its all time high of May, 2008. Down by 93.8% to be more precise.

The ghost fleet. Empty dry cargo ships with nothing to do.

Although there are those who claim to see signals from the Baltic Dry Index that give clear indication as the the future direction of markets, I think those virtues are restricted to only the grandest of scales. There are a couple of good reasons why the $BDI should be considered unreliable as an indicator for 'timing' the markets. The first is that although it measures prices paid for shipping cargo, this is not a measure of the quantity of cargo being shipped. The second and equally important reason is that it tends to be rather capricious. At times, when the index is tracking the equities markets quite nicely, it can suddenly veer off course without warning. The habit of 'suddenly veering off course without warning' is not a particularly endearing characteristic to have at the best of times, let alone if you're in the shipping industry.

In any event, the correlation between the $BDI and the global equities markets should actually be recognized as as being rather flimsy because there are just too many other factors that affect shipping rates. Those factors include the all-import consideration of new cargo ships that are about to hit the water. Not to mention the question of what will happen to future shipping rates as a consequence of the number of new ships that are 'planned', those that are indeed already 'on the drawing board', those that are currently 'under construction' as well as those that are about to be launched. The effect of these added factors becomes quite apparent by noting what happened with the $BDI relative to the world's largest stock market (as proxied by the S&P) back in 2005, and again in the winter of 2010. But generally speaking, yes of course the $BDI normally wants to move in the same direction as the global economy.

We're only going to look at one chart of the $BDI... but in two different scales. First up... the weekly chart in logarithmic scale which in all respects is the best one to use when we're dealing with charts showing large moves on a percentage basis. The most amazing phenomenon to note is the stunningly wild swings that are completely normal for the Baltic Dry Index. Each and every one of the white dashed lines on the chart below represents a move of 44% or greater. There's no getting around it, this would be a remarkable characteristic for the movement of any market or index. The graphic below represents the very epitome of 'volatility':

Click here for a full blown live version.

I draw your attention to the 3 blue rectangular boxes, particularly the one on the left. For nearly a full year encompassing almost all of 2005, the $BDI was on sell mode and yet the correlation with the equities markets was pretty much zero. In fact, in that period of a single year the $BDI lost 72% of its value and the global stock markets didn't even flinch. In fact the S&P gained approximately 17% during the same period. A similar event occurred in the second blue box depicting late 2010.

But on the larger picture, the most stunning statistics are these:

The $BDI peaked in May. of '08. By time it hit bottom 7 months later, it had lost 94.4%.

From its Dec. low, when it bounced, it bounced hard...gaining 547% in 6 short months.

And more recently, between late '09 and today, the $BDI has again lost 84.4%.

Net result... between their respective peaks of late '07 through to today, while the entire NYSE has lost 24.2%, the $BDI is currently sitting with a loss of 93.8%. And that my friends, is not a sign of inflation within the shipping industry. And whether there be new ships hitting the water or not, neither does it signal any great degree of robustness within the global economy. Perhaps it signals the opposite? Oh, I think maybe that's what it's signalling. Imagine the agony those shipping giants are going through when they are unable to charge higher prices for their services and yet the price of their greatest expense, fuel, continues to hold at a high level. What's going to happen to those shipping giants when oil spikes due to a certain to occur war with Iran? They're not going to gain anything from shipping oil that's for sure. Neither are the oil shippers because if there's any one thing we can be totally certain of, it's that once that war breaks out they'll be shipping less oil, not more. Surely at least a few shipping corporations will be facing bankruptcy sooner or later. And that prospect could hardly be viewed as providing an inflationary outcome either. Sombody's not going to be paid back the money he's owed. Needless to say that prospect too is the very definition of deflation... the disappearance of money right out of existence.

And now for a different type of drama effect (as if the log scale wasn't dramatic enough), we look at the same chart (shorter time frame though) in order to zero in on the more recent action and using the more commonly used linear scale:

Click here for a full blown live version.

Man, if that isn't a classic cup and handle pattern I don't know what is. What I do know though, is what happens when I turn a cup upside down. I get a friendly reminder from the Maitre'D that if I keep doing that I risk being tossed from the restaurant. The other thing that happens is that all the contents of the cup spill out. From that aspect, the outlook for the $BDI is all of a sudden looking quite grim indeed. The only saving grace might be the Dec., 2008 low of 663. Will it hold? It's very difficult to say of course, but with the downward momentum currently behind the $BDI's January crash it's difficult to imagine what kind of miracle would arrest the decent at that level. Before we could even begin to consider a bottom in this amazing crash we would want to see at least some form of stabilization. But wait! We just did! And the Baltic Dry failed miserably to advance after a full 8 months of consolidation followed by a false break-out. That particular type of pattern in itself is a very bearish event. We would have to see prices improve to the point where, at the very minimum, the 6 week moving average turns higher. One question often asked is "Well it has already lost 85% so how much further can it fall?" And the answer as always, is of course: "It can fall another 85%".

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