Investment Focus

As this edition concerns logistics and transport within AsiaI thought I would spend some time discussing a shippingindicator, and what many people also believe can predict

economic activity (and potential investment returns) - The BalticDry Index.

In 1998 the Baltic Dry Index (BDI) was created by the UK-basedCompany Baltic Exchange Ltd with the ambition of offering a reli-able measure of the changes in cost of raw material sea transporta-tion. The BDI is a composite of the Baltic Capesize, Panamax,Handysize and Supramax indices. It is an assessment of the aver-age price to ship raw materials (such as coal, iron ore, cement andgrains) on a number of shipping routes (about 50) and by shipsize. It is thus an indicator of the cost paid to ship raw materialson global markets and an important component of input costs. Assuch, the index can be considered to be a forward indicator of eco-nomic activity. Put simply, if there is a high demand to ship goodsglobally you would expect high shipping costs and high economicactivity in the future as the goods are delivered, received andprocessed. Equally the inverse theoretically should be true, if thereis a lower demand to ship goods globally you would expect ship-ping costs to drop and economic activity to be lower in the futureas there would be fewer goods in the chain.

This theoretical environment was highly favorable to the use ofthe BDI as one of the most respected leading macroeconomicindicators by many leading economists and institutions. Indeedit proved to be reliable for a while as it worked during the 2000and 2008 crisis. Since 2009 however the correlation has divergedraising doubts on the validity of its use. Aside from the reducedcorrelation since 2009 we have also seen heightened volatility as

illustrated in Fig 1 below. Since the peak in 2008, the index haslost close to 90%, making this an investor’s nightmare, butpotentially a traders dream.

When looking further into the detailed reasons behind this erraticbehavior, a couple of observations can be made. The main one isa lagging effect: ships are ordered when freight costs are high butcan be delivered at a time when the demand is low, thereby caus-ing a further drop in freight transportation costs and misleadinginvestors on the idea that the trade volume could be worsening.As an example, leading up to the financial crisis shipping compa-nies expected the show to go on. That is, they assumed growthwould continue forever. To handle this projected growth, theyordered more ships. This led to a massive oversupply. The globaleconomic crisis also led to a plunge in demand for shipping.These combined factors led to bankruptcies across the shippingindustry. Industry-wide damage like this doesn’t repair itselfovernight. Today, the industry is still undergoing consolidation.

The BDI as explained above is also highly volatile by naturebecause it is linked to instable commodity shipping volumes thatare not dependent exclusively on macroeconomic factors. Forinstance agricultural commodity volume depends on climaticconditions, energy trades can vary according to environmentallaws and worldwide trade volume is impacted every year by sea-sonal effects, and holidays, etc…

So in summary, The Baltic Dry index is probably less of an accu-rate indicator of the economic health of the world nowadaysthan may have been the case, and failing to admit the limitationscan lead to a misreading of not only current economic conditions

but also potential investment oppor-tunities.

Good investing!

DISCLAIMER:  The contents herein havebeen prepared only for general referencepurpose. You must not rely on any ofthe contents, including any opinion orview, for making a decision of any kind,nor should such contents be construedas an offer, invitation, advertisement,inducement, representation, advice orrecommendation of any kind. Youshould consult with a licensedinvestment adviser for obtainingprofessional investment advice that istailored to suit your specific needs andsituation. The Henley Group and itsrepresentatives make no guarantee,representation or warranty and acceptno responsibility or liability as to theaccuracy, completeness or correctnessof the contents herein.

The Baltic Dry Indexz By Paul Brady, Partner, The Henley Group Limited. pb@thehenleygroup.com.hk

Paul Brady

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Figure 1 – UP, DOWN, ALL AROUND – The Baltic Dry Index Since 1985

Source: Bloomberg, Hofstra University