McDonough: Shippers Face Tough Headwinds

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The Baltic Dry Index (BDI), once referred to as "the best economic indicator you've never heard of," has begun showing signs of life after losing about 95% from its historic high in 2008. The BDI is a daily indicator released by the Baltic Exchange that tracks the average dry bulk shipping costs across 26 sea routes.

From a basic economic perspective, the BDI is set by the supply of available cargo ships against the demand for raw material shipments. External factors come into play, of course, including energy prices, port fees and regional issues. Nevertheless, given the BDI's position in tracking global commodity demand coupled with "real-time" data, it is an effective yet oft-ignored leading indicator for global industrial production -- factoring out potential inventory reserves, manufacturers that anticipate a sustained rise in orders need to source raw material inputs before they can meet customer demands.

The chart below shows that the BDI has been a highly effective tool for tracking global economic activity over the past decade. (For the purposes of this analysis, I used the year-over-year change of U.S. imports plus exports as a proxy for global activity.) But given the current economic climate and a potential supply shock, interpreting the BDI right now is not as straightforward as it might seem.

Baltic Dry Index (BDI) Bloomberg

U.S. Imports + Exports (yoy) vs. BDI (yoy) Federal Reserve

After reaching all-time highs in mid-2008 thanks to China's insatiable demand for natural resources, the BDI experienced an unprecedented drop of nearly 95% by year's end. To help put this into perspective, an article published by The Independent noted that at its peak, the cost of a coal shipment from Brazil to China would have been $15 million, compared to just $1.5 million by the end of 2008. But since the beginning of 2009, the BDI has begun showing signs of recovery, reaching a seven-month high this past week.

A casual observer might take this as the beginning of an upward trend in global economic activity. It is unlikely, however, that the BDI's current rally can be sustained -- it has resulted primarily from a Chinese government stimulus package that stoked the country's imports of iron ore, coal, and copper, combined with companies looking to take advantage of historically low commodity prices to boost reserves.