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When the Baltic Dry rises, the sun comes out

Finance Blogger: Anthony Harrington Anthony Harrington

Imagine an index that shows you the future of the global economy six months hence, virtually uncluttered by the machinations of speculators. We speak, of course, of the Baltic Dry Index, which right now is on the up and up.

The Baltic Dry Index is the Baltic Exchange’s running score of shipping prices on forward freight contracts. If ships are in demand, prices go up. If the global economy is stalling and numbers of large container ships are languishing at anchor, prices plummet. When the global economy starts to rev its engines, demand for raw materials, and hence for shipping, heats up and the Baltic Dry starts to rise.

What makes the Baltic Dry such a wonderful bellwether of the state of health of the world’s major economies is simple. Before grand projects can be built, unless the economy in question involves a resource-rich country such as Brazil, the bulk raw materials for the project have to be shipped from such a resource-rich country to the “user” country. This means charting a ship.

On November 20, the Baltic Dry Index hit its highest point for 2009, which should give tremendous heart to businesses everywhere, since this is a tremendous signal that companies and countries are starting to build and make things again. What makes the spike in the BDI particularly noteworthy is that prior to the real onset of the global downturn in the third and fourth quarters of 2008, shipping companies had been building new container ships at a frantic rate, responding to massive international demand for bulk freight-carrying capacity. Then demand fell off a cliff at just about the same time as numbers of new ships were entering service, leaving those ships swinging at anchor with not much to do.

With the BDI measuring the procurement cost associated with moving bulk cargoes, one would expect it to be wallowing at a low level until all this surplus shipping capacity had been soaked up. This “soaking up” has happened in an astonishingly short time frame—another sign that the big emerging economies of China and India are picking up speed.

Wonderful as the Baltic Dry Index is as a sign of what the global economy is likely to be doing six months or so hence, there are a handful of factors with only a tangential relationship to global demand for commodities, that can impact the index significantly (which adds a smidgeon of complexity to interpreting the significance of movements in the BDI). We have already seen that ship supply is a crucial factor, since as owners take delivery of a new wave of ore carriers, carrying capacity shoots up and prices per ton fall. Just before the global crash the order books of the world’s large shipyards were jammed to capacity and no new orders were being taken for delivery before late 2009. (Owners who did not get their orders to the yards in time would have gone from despair to joy when the downturn hit, leaving new ships with nothing to carry). Other factors that cause the BDI to twitch are cold weather (which increases global demand for coal shipments for electricity generation) and rising fuel prices (with the price of oil being increasingly seen as a proxy for inflationary expectations). When the price of bunker fuel rises the BDI rises since the cost of shipping a ton of raw material increases.

However, while it would be a mistake to do a straight point-to-point interpretation mapping the BDI to incipient global growth, it remains one of the best indicators we have—and a highly visible one at that.

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Tags: economic recovery , exports , financial crisis , global imbalances , manufacturing , shipping
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