Darren Winters: Baltic Dry Index

Attempting to predict economic the movement of indicators, such as the likely trajectory of the world's Gross Domestic Product and therefore future demand for commodities such as oil, or the trajectory of currencies, can be daunting. There are, however, clues that can help us gauge the market's trajectory.

For example, the Baltic Dry Index is often overlooked by mainstream but it can be a useful factor in the equation when trying to make an intelligent guesstimate of the trajectory of certain asset prices.

So what is the Baltic Dry Index (BDI), also known as the "Dry Bulk Index"?

The BDI is a shipping and trade index, created by the London-based Baltic Exchange, that measures changes in the cost to transport raw materials such as metals, grains and fossil fuels by sea. The Baltic Exchange directly contacts shipping brokers to assess price levels for a given route, product being transported and time to delivery (speed).

BDI is a composite of three sub-indexes that measure different sizes of dry bulk carriers (merchant ships) - Capesize, Supramax and Panamax. Multiple geographic routes are evaluated for each index to give depth to the index's composite measurement.

Changes in the Baltic Dry Index will give you an insight into global supply and demand trends. The change in the BDI is often considered a leading indicator of future economic growth (if the index is rising) or contraction (index is falling) because the goods shipped are raw, per-production material, which is typically an area with very low levels of speculation.

The supply of large carriers tends to remain very tight, with long lead times and high production costs, so the index can experience high levels of volatility if global demand increases or drops off suddenly. The Baltic Exchange also operates as a maker of markets in freight derivatives, a type of forward contract known as FFAs (forward freight agreements) that are traded over-the-counter.

BDI gets a moderate rating amongst analysts.

Some consider it a good indicator, especially when looking for hints of economic recovery, while others think investors shouldn't rely on it, suggesting that it's a long shot to count on this investment tool as a crystal ball to foresee the direction of stock markets or the global economy.

The Baltic Dry Index is a barometer for shipping costs of dry bulk commodities.

Global shipping brokers are asked every workday about their pricing by the Baltic Exchange. The Baltic Exchange consists of more than 600 members as of October 2010, including professionals in the international dry shipping industry and maritime lawyers and arbitrators. The exchange calculates the Baltic Dry Index by estimating the average time charter rate of four indexes that represent the vessel types. Each of these vessels makes up 25% of the Baltic Dry Index.

So what does it mean when the BDI fluctuates?

A rise in the BDI is often interpreted as a bullish signal. If the market is demanding more shipping freight space, then that is an indication of a stronger demand for commodities. If producers are buying more materials, it implies that companies are growing. In other words, when the shipments increase, economies are doing well.

Alternatively, BDI that trends downwards is a bearish signal. Less demand for shipping means slowing trade and stagnating consumer demand and an indication that companies are slowing down their production.

I like the BDI because the data is more difficult to manipulate, you are drinking close to the source. Actions are limited to those involved with the contract: the people with the cargo and those who have the ship for the cargo. Thus, the index can't be manipulated as the amount of ships has been fixed.

Nevertheless, the index does have it’s shortcomings.

BDI can be very volatile, at times simulating a roller coaster ride on the charts. The recession that began in 2007 illustrated these swings - hitting extreme highs and severe lows.

By late January, 2008, the BDI dropped 6,052 points, only to reach its all-time high of 11,440 points in June 2008. But as of November 31, 2008, the index was at its lowest level since January of 1987 - 715 points, added the report.

Some analysts would say that BDI isn't a useful indicator to determine the stockmarket trajectory. In 2009 BDI was negative but stocks rose. I would argue that is because a QE inspired rally fuelled a bull market, but had little impact on the fundamental economics. In other words, we had negative divergence with stocks heading north and the fundamentals deteriorating.