Why the Baltic Dry Index, a Crucial Economic Indicator, Is Broken

A proxy for global supply and demand for almost every commodity on the planet would be an important economic indicator and a quick and easy way of taking the temperature of the lifeblood of the global economy.

That is exactly what the Baltic Dry Index has been for the past three decades.

Managed by the Baltic Exchange in London, the BDI is a measure of world trade. It measures the cost of shipping everything from coal to copper using dry bulk cargo ships.

But the BDI may no longer be the powerful indicator it once was.

Two key drivers of the BDI have undergone significant shifts since the index peaked in 2008: the supply of cargo ships and the Chinese economy.

The BDI tracks shipping prices, and they are at all-time lows. In fact, late last year one could easily rent out a 168-meter cargo ship, big enough to carry 10,000 elephants, for less than what it would cost to stay one night at the Ritz-Carlton in Singapore.

The index hit its lowest level ever in February. And even though the BDI has climbed sharply since then, it is still 9% lower than it was in December 2008.

To put that in perspective, a key barometer for the global economy is lower than it was at the depths of the global financial crisis of 2008.

The index followed commodity markets down, which makes sense, considering the fact that shippers are likely to pay less to transport commodities that aren't worth as much as they used to be. Take a look at the correlation between the BDI and the S&P's GSCI Total Return Index, a measure of global commodities prices.

 

When shipping prices and shipping demand were higher not too many years ago, more cargo ships were ordered to meet the demand.

But it takes several years for a new cargo ship to be built. As these extra ships were being built, commodities prices collapsed, and the demand and price for shipping fell, too.

As a result, hundreds of cargo ships are idle as demand shows no signs of recovery. Ship operators continue to drag themselves through the market, with many operating their ships at a loss.

But shipbuilders are still building new ships.

Boston Consulting Group reported in 2014 that global shipping capacity will expand 30% by 2019.

All this adds to the existing glut of shipping capacity that is keeping shipping costs so low and will keep them low for the foreseeable future.

But the death of the BDI is about more than a glut of cargo ships. It is also about the state of China's economy.

China's economy has been in the news for all the wrong reasons of late.

It is in the midst of a transition period, moving away from its role as the world's sweatshop and adopting a strategy focused on services, much like Europe and the United States. Countries such as Bangladesh and Vietnam are already undercutting China's rising labor costs and taking manufacturing jobs.

This isn't to say that China's role in the global economy is shrinking. Rather, the role China plays is evolving.

It will continue to be a major production center but for value-added goods such as solar-power panels and smartphones, instead of cheap plastic cups and T-shirts.

With less manufacturing, China will need fewer raw materials. China accounts for more than half the entire world's commodities demand.

China buys more concrete, aluminum, copper and steel than any other country in the world. But as services have started to play a bigger role in the world's second-largest economy and its demand for commodities has leveled off, the impact on commodities prices has been severe.

Too many ships and falling demand from its biggest customer effectively puts a cap on the BDI. This key indicator may never be the same again, and it certainly won't be reaching its historic highs of 2007-2008 for a very long time.

But the index doesn't need to touch extreme highs to indicate growth in the global economy. For the time being, all it shows is the dimming prospects for shipping companies such as Eagle Bulk Shipping, Genco Shipping & Trading and Scorpio Bulkers. 

Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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