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Why the Baltic Dry Index matters

For those who believe in a long, golden era of booming commodities and happy theories about emerging markets “decoupling” from the US and its problems, we say: it’s time to look again at that fascinating gauge, the Baltic Dry Index - now more than 40 per cent down from its peak last November.

As the key measure of global shipping costs for dry bulk commodities such as grain, iron ore and coal, the BDI is the window on what CLSA’s Christopher Wood described in his client newsletter Greed & Fear last November as the “supreme cyclical indicator”.

The recent collapse of the index is a strong signal that the boom in agricultural commodity prices is about to come to an end, says Julian Jessop at Capital Economics. in the FT’s View of the Day column on Wednesday.

He notes that some observers have attributed the drop in the BDI to an increase in the number of ships able to carry dry commodities, or to temporary port closures.

But he says such a rapid fall in shipping prices seems at least as likely to reflect demand-side factors. The decline in the BDI is also a warning sign for the prices of commodities in general, Jessop adds.

“Indeed, we are sceptical of the widespread assumption that strong demand from developing economies will inevitably continue to put upward pressure on commodity prices,” he says. “In particular, continued rapid growth in Chinese demand cannot be taken for granted as the economy rebalances away from commodity-intensive investment.”

And as for commodities prices and “decoupling” theories, Lex last week gave the bad news, pointing out that the lock-step bounce in global securities markets after the Fed’s emergency 75bp rate cut on January 22 showed that decoupling has yet to take hold in financial markets. With the exception of gold, falls across a broad range of commodities - the “darlings of decoupling enthusiasts enamoured with China’s seemingly unshakable development” - were “at least a partial admission of this”, and the BDI “helped point the way”, Lex said.

However, as always, when it involves a lot of money, there are wheels within wheels. A recent theory doing the rounds of the shipping and commodities world lays blame for the slide in dry bulk shipping rates - and consequently the BDI - on a single Taiwanese shipping magnate: Nobu Su, whose privately held Taiwan Maritime Transport is the largest participant in shipping futures markets, according to the FT’s transport correspondent Robert Wright.

Wright reported last week that Su denied playing a pivotal role in the past few weeks’ decline of dry bulk shipping rates, saying it resulted from fundamental market changes.

But participants in dry bulk markets have attributed the decline in rates from last year’s record highs partly to TMT’s heavy betting on a fall in futures markets. There have also been claims from competitors that Mr Su, chief executive, has helped to push rates towards his position by chartering out some of his 130 ships at below market rates.

TMT excites strong passions because of its reputation for making large — and often successful — bets on rate movements in the futures market. It is also unique among large futures market players in owning a substantial fleet of ships.

Not surprisingly, Su through his spokesman told Wright he could not have moved the market on his own. “It’s no longer the case that one man could single-handedly influence the direction of the market,” he said. Since when, we wonder?
On the claim that TMT was chartering ships at below market rates to bolster its futures position, Su said he simply aimed to get the best price. “Sometimes it’s below the market average, sometimes above,” he said. “It just depends on the price we’re offered.”

In a separate post for FT Alphaville last week - which contains a beautifully clear explanation of BDI mechanics and how they relate to the fallout from the SocGen trading scandal - Wright examines the conspiracy theories about flailing commodities prices because, he says:

Before Thursday’s SocGen revelations, analysts had found a new favourite indicator to justify falls in equity prices. It could be, of course, that the many analysts who have talked up in the last fortnight the significance of the plunge in the Baltic Dry Index — it’s down 40 per cent from its record peak in November — are long-term, serious students of freight rates.

This entry was posted by Gwen Robinson on Wednesday, January 30th, 2008 at 9:52 and is filed under Capital markets. Tagged with . You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.

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Comments

  1. Feb 03   17:11 Posted by bdp1 Consulting Ltd [report]

    I have to agree with Nigel here. I look at shipping all day long- I focus on one of the underlying indices, the Baltic Capesize Index, and, in particular a composite of four geographical routes (evens things out- backhauls, fronthauls, etc) for Capesize Bulk Carriers. By Friday Feb 2 this composite was back over $100 K/ day. Now the forward curve for 2008 is virtually flat, ie people think this will be the rate throughout 2008. Going out, $77K for 2009, $56K for 2010 and $45K for 2011. If you talk to most traders, they would blame the downward sloping expectations on more ships coming in during the further out years, moving utilization rate down in those years- rather than on a collapse of demand. In theory, daily breakeven for a Capesize is circa $30K - $35K day if ordered at prices for delivery in out years, and depending on financing assumptions, so FFAs would have even more downside.

    But the pricing for 2008 FFAs, settles quoted by Baltic Exchange and Imarex, are worth watching. At this point, the commodity collapse does not seem to be indicated for 2008 anyway. Mid last week, a long term iron ore contract was agreed between BHP (seller) and Baosteel in China (buyer), which improved sentiment.

    I know in 1980’s Jim Grant of Grant’s Interest Rate Observer seized on Baltic Freight Index (sort of like BDI, in mid 1980s time warp sort of way) as an indicator of world trade. But his romance with this indicator did not seem to last that long.

    Guys on Cramer’s TV show on CNBC fail to grasp that BDI is industrial raw materials, which buyers and sellers of of “DSX” and “SSW” did not seem to grasp.

  2. Feb 01   11:34 Posted by Nigel Prentis [report]

    I enjoyed Gwen Robinson’s well-written piece on the BDI but beg to differ in various respects. The BDI fell sharply from its peak in mid November on micro shipping supply and demand fundamentals rather than on any macro factors relating to the economic cycle.

    Force majeure on significant iron ore volumes ex Brazil, followed by force majeure on iron ore exports from Western Australia - the world’s two largest suppliers - tipped a lot of capesize tonnage into the market which caused a collapse in rates, starting with the larger sizes and filtering down to smaller ships. There was no change in demand, just unexpected constrained supply.

    The ongoing iron ore price negotiations, the proximity of Chinese New Year, instability in financial markets and some heavy short selling in the freight futures market all served to fuel negative sentiment and send the physicals down. Fundamentals are now reasserting themselves and this week the Baltic indices are moving up, led by the BCI which is up 22% Monday to Thursday.

    Commodity sell-offs are not surprising after having done so well last year. Analysts that have flagged up the BDI as a forward indicator of the end of the commodity super-cycle probably helped this process a bit. A larger portion of selling would have been to meet margin calls on equity futures as you need to sell the good stuff in order to pay for the bad stuff. Gold is subject to the same selling pressure, as well as profit-taking on its upward trajectory.

    Financial market analysts have seized on the BDI as a forward indicator of broader economic developments, although many of them had never heard of the Baltic Exchange until recently. Tread carefully, 2.5 billion people in China and India now feel entitled to a higher standard of living and this is totally de-linked from the problems in the so-called developed world that flow from the US subprime crisis.

    Any failure of their governments to deliver on past implicit promises, which requires massive investment in infrastructure and social welfare, will be a problem for them and, eventually, a problem for us all. As failure is not an option, then the spending will continue and at an accelerated rate if weakness in export markets and capital inflows requires state intervention.

  3. Jan 31   16:35 Posted by Good to Go Pile . . . « Trading for the Masses [report]

    […] Leading Indicators […]

  4. Jan 31   16:35 Posted by Good to Go Pile . . . « Trading for the Masses [report]

    […] Leading Indicators […]

  5. Jan 31   2:31 Posted by bdp1ConsultingLtd [report]

    Forward freight agreement (FFAs) on routes that make up the BDI are UP. Capesize composite (4 time charter rates) is going for more than spot, so I would caution about following one index that reflects the vacuum in the market. From mid January to late January, the “Calendar 2008″ FFA’s shot up from $87,000/ day to $113,000/day in the Capesizes, and from $34,000/day to $43,000 in the Panamaxes. Can’t tell the bow from the stern? FFA traders think that rates are going to move up.

    Anyway, thinking is that a big iron ore contract got signed today by Baosteel so sentiment is back up.

    Mr. Su’s TMT also owns a nice chunk of a listed entity on Nasdaq “SBLK” so it is not so unilateral as willing the market to go down. The spat between Mr. Su, and DRYS Chairman has been amusing but both of these guys benefit when things go upward.

    bdp1 Consulting Ltd

  6. Jan 30   15:05 Posted by Baltic Dry speculation « a neoconservative, mugged by Hobbes [report]

    […] Commodities hounds have noticed that the Baltic Dry Index has tanked 40 percent since November. Bearish for commodities, right? You would think so … except …. A recent theory doing the rounds of the shipping and commodities world lays blame for the slide in dry bulk shipping rates - and consequently the BDI - on a single Taiwanese shipping magnate: Nobu Su, whose privately held  Taiwan Maritime Transport is the largest participant in shipping futures markets, according to the FT’s transport correspondent Robert Wright. […]

  7. Jan 30   13:31 Posted by Boz [report]

    Weakness in commodity prices!! what weakness in commodity prices!! Dated Brent above 93/bbl on my screen…

This post is closed to further comments.