Tuesday, December 02, 2008
The Baltic barometer
Tuesday, 02 December 2008
With the recent volatility in the markets, recession fears are prevailing everywhere. Amid the general lack of certainty about the future, people naturally are not only asking "what's going on?" but also "where's it all heading?" It is in times like these that it is very helpful to pause and reflect on the past and the great words of former US president Franklin D Roosevelt. "We have nothing to fear but fear itself," he told the American people at the onset of the Great Depression.
So what does that statement have to do with the Baltic Dry Index.
The BDI is a valuable tool that helps indicate where we are in the economic cycle and can point to future directions and changes in the markets.
Founded in 1774, the BDI traces its roots and takes its name from the Virginia and Baltick coffeehouse in London's financial district.
Every day the Baltic talks to brokers around the globe and asks how much it costs to ship a cargo of raw materials on a given route, for example iron ore to China from Australia?
According to the Baltic Exchange, the index provides an assessment of the price of moving raw materials by taking into account 26 different routes on a time charter and voyage basis.
It covers the voyages of the big bulk carriers, known variously as supramax, panamax and capesize, that carry various commodities such as coal, iron ore and grain.
Why is this important? Well, economists will argue over the leading economic indicators and these will sometimes frust
rate even the wisest. Rather than poring over unemployment numbers and discussing consumer spending and confidence and its impact on gross domestic product, an easier and simpler way to take the pulse of the economy is to consider the BDI.
Put simply, as the BDI goes up so does the cost of raw materials.
What makes the BDI special is that it is a leading indicator that is, it tends to move ahead of the price of commodities and is therefore more valuable than a backward looking or lagging indicator.
It is also one of the purest indicators as it is virtually devoid of speculative players, being limited to member companies, parties securing contracts, cargo suppliers and shipowners.
From 2005 to last year, we saw a massive increase in the BDI primarily due to Chinese demand in combination with other factors such as a shortage of supply in dry bulk cargo ships and a backlog at shipyards.
Early this year, we saw investors trying to hedge against inflation by shoring up their portfolios with hard assets.
This in turn contributed to the rapid increase in commodity prices. But price does not always indicate demand as there are substitution effects and the impact of futures contracts sometimes makes it difficult to gauge fair value and true price.
In other words, commodity prices can remain elevated in spite of the supply and demand situations that indicate differently.
The index has now plummeted to 2003 levels. Chief among the causes for the plunge is the rapid slowdown in the global growth phenomenon.
In addition to this, credit has been nearly impossible to get for the purchase of goods and the payment of time chart ers on vessels. Here we have another victim of the credit crunch as letters of credit and the credit lines for the shipping trade are currently frozen.
Nothing is moving because no trader wants to take the risk of putting cargo on the boat and finding that nobody can pay.
There are many statistics that can be controlled, but the one that authorities cannot control is the Baltic Dry Index.
Julian Galvin is an Associate Director at Tyche Group, an independent financial advisory firm based in Hong Kong
As adapted from Hong Kong The Standard
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