The unreliability of the Baltic Dry
SINCE the end of May, the Baltic Dry Index, which measures worldwide international shipping prices of dry bulk, has plummeted some 50 per cent. It has now fallen for 31 consecutive days – its worst run in more than six years – raising concerns among investors about both the outlook for world trade and for commodity prices.
The index is supposed to reflect the underlying demand for commodities transported by sea. So if you are betting on the price of commodities such as metal ores and agriculture, or on equity sectors such as mining, basic resources or industrial goods, you might well be somewhat concerned by the index “falling off the proverbial cliff” as Gluskin Sheff’s David Rosenberg puts it.
But the usefulness of the index, which has been regarded by economists as a bellwether of global trading activity and often as a leading indicator of commodity prices, has started to come under fire. Indeed, Ian Harwood at Evolution Securities says: “What you most definitely shouldn’t look at to judge world trade momentum, however, is the Baltic Freight Index, a measure of shipping costs”.
Capital Economics’ Julien Jessop also advises that traders should be wary of making big calls on commodities (or anything else) on the basis of the Baltic Dry Index. This is for two reasons. First, he points out that fluctuations in the index could be driven by changes in the supply of shipping as well as in the underlying demand for commodities transported by sea and could equally be distorted by temporary port closures and changes in the cost of fuel and insurance.
He says that there was a surge in orders for new cargo ships in 2007 and 2008 at the peak of the global commodity price boom and given that it takes two to three years to build a ship, these could be coming on stream now. “It is at least conceivable that the Baltic Dry Index could fall further this year even if commodity prices rebound, provided the corresponding increase in demand for shipping is more than offset by an increase in supply.”
Second, Jessop says that the index’s record as a leading indicator of commodity prices is pretty poor. Since you can observe spot and future commodity prices anyway, it is not much use as an additional forecasting tool, he argues, adding that it has often sent misleading signals, particularly for industrial metals such as copper. He acknowledges its more reliable correlation with agricultural commodities, which reflects their greater importance in the dry bulk shipping market.
But for now, if you are looking to take a punt on world trade activity through commodities and related equities, what indicators should you use?
Evolution Securities’ Ian Harwood says that very useful forward-looking indicators of world trade are the Asian trade figures, notably those of Korea. Air freight is also an excellent leading indicator of overall world trade as is the global purchasing managers’ export orders index.
So if you do have bets reliant on trade activity, don’t panic too much about the fall in the Baltic Dry Index and base your decision on a wide range of indicators.