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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.

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.

Without a global uptick in demand for Chinese goods, these levels cannot likely be sustained; portions of these imports are just adding to growing reserves. Further downward pressure will come in the form of a supply shock on the horizon. Shipping companies looking to take advantage of historically high margins contracted a record number of new vessels from 2005-08, most of which are scheduled for completion over the next two years. According to Lloyd's List, a leading journal for the maritime industry, 492 vessels -- or 9.6% of the bulk tonnage on order -- have been canceled since the crisis began.

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Roy Thomson, a regional manager in Asia for Lloyd's Register, indicated at a recent conference that he expects that number to rise further and that current cuts will not circumvent a supply glut. In all, this confluence of factors should place downward pressure on dry bulk carriers and ship builders.

The headwind pressure should be especially apparent in the Delta Global Shipping Index -- a metric that contains 30 global maritime shipping stocks -- which is why I'm bearish on

Claymore/Delta Global Shipping

(SEA) - Get Report

, an ETF designed to track this index (see chart below). The SEA includes such companies as

Eagle Bulk Shipping

(EGLE) - Get Report

,

Diana Shipping

(DSX) - Get Report

,

Frontline

(FRO) - Get Report

,

Alexander & Baldwin

(ALEX) - Get Report

,

General Maritime

(GMR)

and

Ship Finance International

(SFL) - Get Report

.

Both the Delta Global Shipping Index and the SEA are coming off interim lows and will likely face some depreciation as demand for shipments diminishes. As for the BDI, I expect it will remain rangebound between 1,500 and 3,500 through 2010, mostly dependent on the magnitude of any economic recovery and supply management of new vessels.

Unsustainable demand coupled with a capacity glut will place significant strains on dry bulk margins through 2010. Furthermore, highly leveraged shipping companies, with extensive ongoing new vessel orders, will face even greater pressure over the coming months.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider General maritime and Ship Finance International to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, McDonough had no positions in the stocks mentioned.

Michael McDonough is an independent research consultant in North America and Asia. Over the past two years, he has advised hedge funds, central banks, broker-dealers and corporations on a range of economic and financial issues. He is also the creator of

Fiat Economics

, a global financial/economics blog. McDonough has worked on Wall Street as an economist, specializing in the U.S. and Latin America.