Conclusion: While exogenous factors have driven the BDI index lower, the next move should be driven by growth, either an acceleration or deceleration, with the BDI likely being a leading indicator. So, keep your Hedgeyes on it.
We recently noted this, but wanted to highlight the point again. The Baltic Dry Index is down to an 18-month low. In fact, it most recently dropped 4.5% to 1693, taking out the July 2010 low. The largest BDI vessels, Capesize, led the way declining more than 6%.
As we wrote this summer, the Baltic Dry Index is very a relevant global macro data point. As was recently written in Slate, “Because dry bulk primarily consists of materials that function as raw material inputs to the production of intermediate or finished goods, such as concrete, electricity, steel, and food, the index is also seen as an efficient economic indicator of future economic growth and production. The BDI is termed a leading economic indicator because it predicts future economic activity.” Further, “Because it provides an assessment of the price of moving the major raw materials by sea, it provides both a rare window into the highly opaque and diffuse shipping market and an accurate barometer of the volume of global trade -- devoid of political and other agenda concerns."
We actually looked at the correlation between the Baltic Dry Index and global growth on an annual basis going back to 1993 and didn’t find a strong correlation between the two. This is primarily because while growth and demand for goods clearly and logically will lead to increased demand for shipping, there are other factors that drive the price of shipping contracts. Specifically, the two key factors that drive the price of shipping contracts: the supply and demand of ships.
The supply factor is obviously driven by the building of new ships (and likely to some extent the availability of financing and reasonable terms). Currently, oversupply is an issue. In fact, last year the supply of ships grew 17%, while demand grew only 11%. This is widely known news though, and has likely been discounted into rates for the past couple of quarters.
Conversely, the demand side of the equation is driven by the economic activity and general demand for dry bulk goods. Currently, there is an exogenous shock occurring on the demand side of the equation due to massive flooding in Australia. According to news reports, floods covering areas the size of France and Germany in Australia have damaged crops and led to a shutdown of mines. Due to the exogenous events, many Australia miners have implemented force majeure and cancelled contracts. As a result, there are 66 dry-bulk carriers idle near Brisbane. This too is widely disseminated news and likely priced into rates.
Clearly, with these exogenous events leading to a more than 45% decline in the BDI index, if global growth is going to accelerate in 2011, or even occur at high rates, we should see a pickup in the BDI. Keep your Hedgeyes on it.
Daryl G. Jones