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Baltic Dry gets the punters in a spin

Baltic Dry | Baltic Dry gets the punters in a spin Anthony Harrington

Take an index that many of the “smartest” economic commentators like to use as a bell-weather for the coming ups and downs of the next six months and, well, wobble it up and down a bit, and what do you get? The answer, of course, is a good deal of froth and confusion.

The Baltic Dry Index maintains a league table of the prices being commanded by ships of various sizes, from the Cape sized ships that are too big to go through the Suez Canal, to the “handy” sized smaller container vessels that are the stock in trade of many lines. The index is generally regarded as a good indicator of where the global economy is headed six months from now. If trade is picking up demand for ships rises and freight prices rise accordingly. If many ships are swinging on their anchors doing nothing, prices plummet and six months from hence you know that not very much is being shipped anywhere, so expect the global economy to be heading south.

This is all simple enough, but as I noted in a blog on the Baltic Dry back in December 2009,, there are factors which complicate how the Baltic Dry behaves and which turn this nice simple reading of the index into a perilous exercise. The biggest of these complicating factors is the crisis that is currently sweeping the global shipping industry.

This crisis was wonderfully illustrated in a recent webcast featuring Lloyds List editor Tom Leander and three of his colleagues (registration required). The point they make is that the big global ship owners look, from the outside (and possibly from the inside as well) to be behaving bizarrely right now, which is to say, against their own interests. Why? It will take a moment to explain, but the nub of the matter is that they are buying up “bargains” and newbuilds (ships under construction or due to be constructed) despite the fact that the market is glutted with excess shipping capacity – i.e. economic logic says that they should be sellers, not buyers.

The ship market is glutted because at the height of the boom there was a chronic shortage of shipping to carry the massive increase in the world’s freight. This created very attractive freight prices for ship owners, so naturally, they all placed orders for more ships with whatever shipyard around the world still had capacity. There is a long lead time on ship builds and at £100 million or more a pop, yards sign tight contracts with potential buyers. Even had the market been buoyant, the general feeling is that too many new builds were ordered. Instead of being buoyant, however, global trade has gone backwards through the downturn.

So why are ship owners buying? There are two schools of thought on this. One is that hey, they understand ships, they have surplus cash right now. They can’t get a decent return on that cash in a low returns investment environment, so why not invest in something they understand? The other line of thought is that they can’t help themselves. They’ve spent their whole lives looking at ship prices and if they see something way cheaper than it “should” be, they buy it. A ship is for 25 years, a bad market is for a few years. So they are thinking long term smart – provided they can stave off bankruptcy in the short term.

To make matters worse, China, which is far and away the most massive generator of demand for iron ore carriers, has cut back sharply on its requirements. This combination of excess capacity and weakened demand has caused the Baltic Index for Cape sized dry bulk carriers to crash from 5,520 in May 2010 to 1,676 by mid August, as highlighted by Ambrose Evans-Pritchard’s blog in the Telegraph

So, the puzzle for Baltic Dry watchers is this. Is the sharp fall in the index a natural response to overcapacity? If it is, then this is not telling us a great deal about the health of global trade six months hence. Or is it a direct response to China taking its foot off the growth accelerator? In which case, yes, the Baltic Dry is telling us that we are in for a grimmer time over the next six months than many were hoping for. And yes, a double dip recession has sidled a few paces closer.

Further reading on recessions, depressions and recoveries

Tags: Baltic Dry Index , China , economic recovery , global growth , recession , shipping
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