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For those of you who follow MAYBULK (Malaysian Bulk Carriers Bhd), you will know that its earnings are highly dependant on something called the Baltic Dry Index.

The Baltic Dry Index is a price index compiled by the Baltic Exchange in London. Each working day, the Baltic Exchange canvasses hundreds of brokers around the world for prices to move dry bulk cargo, for example iron ore, coal, copper and grain (there are 26 such items). The prices are then combined to form the Baltic Dry Index (BDI), which appears in shipping publications such as Lloyd’s List.

I’ve come to learn that the BDI is an excellent indicator for economic growth and production.

Why?

BDI doesn’t deal with container ships carrying finished goods.

It deals with the precursors to production – ships carrying iron ore, building materials, cement and coal … raw materials so to speak.

If shipping rates for dry bulk are low (as they are now), it means less cargo is being moved around. We are in for declining global production.

Check out the BDI chart below.

(Source: Bloomberg, click picture to enlarge)

See the spectacular rally from 2006-08? The index peaked at just under 12,000 points.

To give you a feel, the cost of chartering a Capsize bulk carrier was around US$235k per day in May 2008. Now it is less than US$10k!

Up until 2008, China was importing huge amounts of raw materials and churning out exports.

But now the world’s factory is in trouble. Raw material imports have collapsed as a result, and so have shipping rates for dry bulk.

When will the Baltic Dry Index Recover?
The shipping industry relies heavily on Letters of Credit (LC). As liquidity tightened worldwide, so has the issuance of LCs. To cope with this, the market is beginning to see an emergence in export credit (exporter issues a loan to the buyer via export credit agency).

But this will not make much difference to global trade because Export Credits are risky for exporters compared with the traditional LC.

The deflation in commodity prices is now causing companies to use up existing raw material inventories rather than replenishing stocks. Why buy today when it will be cheaper tomorrow?

Eventually inventories will run low and factories will replenish.

As this happens and as global credit markets unlock, we will see stabilization and a marginal recovery in shipping costs.

But is unlikely we will see the Baltic Dry Index anywhere near its peak in the near future.

BDI is Highly Responsive to Shipping Demand
The supply of bulk cargo ships is tight and inelastic – it takes two years to build a new ship. A demand increase can push the index higher quickly. Even more so, significant increases in demand can push the index sharply higher. That was pretty much what happened between 2006 and 2008.

Furthermore ships are not taken out of circulation during slow periods (due to the high cost of docking). A drop in cargo rates does not change the number of ships in operation.

Even a slight change in the demand for dry bulk shipping results in a significant change in the BDI.

BULL or BEAR? Look to the Baltic Dry Index
I don’t know why they don’t teach BDI in economics. It could have saved me a lot of money!

If you’re looking for a clear indication of a market bottom, forget about GDP, Unemployment, Inflation etc. Just this morning we hear of US unemployment reaching 7%. There are still massive layoffs so don’t be surprised if it trends higher. Bottom line is that all the major economic indicators are backward-looking.

If you want a forward-looking indicator to know when business earnings will trend higher, look for the Baltic Dry Index to start trending noticeably higher. I suspect it will be quite a while yet.

Unlike the stock market, the BDI does not have any speculative element. People don’t book cargo ships unless they have cargo to move. Furthermore BDI is not a “tradable” index and that makes it devoid of any speculative element.

The BDI reached its record high of 11,793 points on 20 May 2008. Just 6 months later in Dec 2008, it had dropped to 663 points (down 94%). Current rates are cutting close to operating costs (vessel, fuel, and crew). But it does look to have stabilized at 700 – 800 points.

I have included the Baltic Dry Index in our Indices page.