Why You Should Care About the Baltic Dry Index

The Baltic Dry Index measures the cost of moving some raw materials, such as rocks and rice, across the ocean by ship.

Because raw materials are used at the beginning of a production cycle, indices related to moving them are seen as an important bellwether of future economic activity in the real economy. And that's why investors and economists should take care to watch what's happening, although they also need to be careful how they read it.

Changes in Shipping Rates Matter

"It's viewed as an indicator of commercial traffic," says Michael Darda, director of research and chief economist at MKM Partners in Greenwich, Conn. "Shipping rates are viewed as a measure of demand and they are looked at the same way other commodity prices are."

Freight Stocks Good for the Long Haul

Here's how the Baltic Dry Index works and what it means.

The index figure itself doesn't actually mean anything. Rather, changes in the level of the index reflect rising or declining costs for moving dry freight across the oceans.

To derive the figures, each day the London-based Baltic Exchange consults a panel of experts to assess the cost of moving dry freight over a large variety of well-used shipping routes using a number of different classes of ship, some very large and some smaller.

For this index, the Baltic Exchange only looks at ships fitted to carry dry cargoes, such as iron ore, coal, corn, wheat and barley. Finished goods, such as air-conditioners and refrigerators, are moved more often by container ship, while oil is hauled by tanker.

Prices for the freight can shift wildly between periods. That's because, while demand for freight space ebbs and flows, the supply of available ships doesn't change markedly, and new ships can take a couple of years to build.

The Baltic Dry Index and Emerging Markets

The phenomenon of demand outstripping supply has been particularly prevalent over the past few years as fast growing economies in Asia and the Southern hemisphere have gobbled up materials in the quest for economic growth.

Joe Brusuelas, chief U.S. economist at IDEAglobal in New York, cautions that the index shouldn't be used in isolation to assess what is happening in the global economy. But he says it's still useful.

"It's a decent proxy to interpret growth in emerging markets ," he says and notes the index is very volatile .

The Baltic Dry Index and Freight Stocks

It's not only economists and stock-market strategists who look at the Baltic Dry Index.

Some analysts closely follow the stocks of freight shipping firms, such as DryShips(DRYS Quote), Eagle Bulk Shipping(EGLE Quote) and Navios Maritime(NM Quote).

The fortunes of these companies tend to closely track the Baltic Dry Index, but as with any business, management expertise and company-specific strategies can make a big difference to how well a stock performs.

To learn more about the Baltic Exchange and its Dry Index, visit the official Baltic Exchange Web site.