Baltic Dry Index; an Economic Indicator

[mixin]

This is an older article written By Daniel Gross and posted Friday, Oct. 24, 2003 so part of it isn't relevant to our economy now. It does give a really good explanation as to why we should be paying attention to the Baltic Dry Index.
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[snips]
Every working day, the Baltic canvasses brokers around the world and asks how much it would cost to book various cargoes of raw materials on various routes?150,000 tons of iron ore going from Australia to China or 150,000 tons of coal from South Africa to Taiwan. Brokers are also asked to consider variables such as the type and speed of the ship and the length of the voyage.

The answers are melded into the BDI, which appears in shipping publications such as Lloyd's List and on the screens of information vendors such as Reuters and Bloomberg. Because it provides "an assessment of the price of moving the major raw materials by sea," as the Baltic puts it, it provides both a rare window into the highly opaque and diffuse shipping market and an accurate barometer of the volume of global trade.

The BDI is a good leading indicator for economic growth and production. After all, it doesn't deal with container ships carrying finished goods. It deals with the precursors to production: bulk carriers carrying building materials, cement, grain, coal, and iron. Unlike stock and bond markets, the BDI "is totally devoid of speculative content," says Howard Simons, an economist and columnist at TheStreet.com. People don't book freighters unless they have cargo to move.

(remember, this was written 5 years ago)
Because the supply of cargo ships is generally both tight and inelastic?it takes two years to build a new ship, and ships are too expensive to take out of circulation the way airlines park unneeded jets in the Arizona desert?marginal increases in demand can push the index higher quickly. And significant increases in demand can push the index sharply higher.

As they say on CNBC, what does this mean for you? In this article from late last year, Howard Simons charted the index against the Dow Jones World Equity Stock Market Index and U.S. Treasury 10-year notes. His conclusion: "It's a very good leading indicator." Movements in the Baltic Index tend to precede movements in global stock markets. But the index also tends to presage higher interest rates. When more stuff is being shipped around the world, it needs to be financed. And that creates a greater demand for credit.

http://slate.msn.com/id/2090303/

 

[Laidback Al]

Re: Baltic Dry Index; an Economic Indicator

Thanks for posting this mixin . . . especially an article from 5 years ago when times were good.

"It's a very good leading indicator." Movements in the Baltic Index tend to precede movements in global stock markets. But the index also tends to presage higher interest rates. When more stuff is being shipped around the world, it needs to be financed. And that creates a greater demand for credit.

And five year later I would add that, as a leading economic indicator, the recent declines in the index also presage a serious, long term global economic downturn. The graph below illustrates the precipitous drop in the index since last June (2008). It is now well below the level in 2003 when Gross's article was published. More comparative graphs can be be found at: http://investmenttools.com/futures/bdi_baltic_dry_index.htm

 

[kent nickell]

Re: Baltic Dry Index; an Economic Indicator

Economic forecasting can be as tricky as infectious disease forecasting where there are both trends and surprises... Witness record high oil prices several months ago when prevailing forecasts were that they could only go higher what with limited supply and increased demand from China and India etc... Then oil prices nosedived in parallel with the Baltic Dry Index nosedive...

with that being said...

This is an interesting 18 minute video inteviewing economists Nouriel Roubini (Roubini Economic Monitor, REM) and John O'Neil (Golman-Sachs global economist) with their predictions for 2009

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=alA6WbHcBBrU


Roubini: the stock market could easily lose another 20% in 2009 with continued bad financial news... with the DOW now at about 8500 that would put it below 6000, sees possible very small economic growth in 2010, 2011 (will still feel like recession)

O'Neil: favors debt/credit investments (corporate bonds) over equities (stocks) This is interestingly somewhat of a 'bearish/speculative' play based on the fact that there will be some bankruptcies in 2009 of well placed companies but not all of them... He recommends buying a basket of 25 highly ranked household name corporate bonds because they are paying high yields in anticipation of some of them going bankrupt. but he thinks that with a basket of 25 you will come out ahead with surviving companies outpacing those going bankrupt...

---
Many predictions of global recovery seem to be based on recovery of the US housing market possibly based on government bailouts of homeowners.... (to me this seems like the fly in the ointment... I don't see housing stabilizing much less recovering for another 3-4 years) I think it's a long way from the ninja loan model to the affordable/sustainable model in the neighborhood of people being able to put 10-20% down and have PITI plus utility bills at 25-30 percent of their pretax income (and this also assumes an income...) In addition to ninja loans many people in the prime credit market were also buying homes where they were paying interest only teaser mortgages at 3%... there has been an abrupt change in this credit market that we're just beginning to get the feel of....

 

[mixin]

Re: Baltic Dry Index; an Economic Indicator

I don't fully understand what this graph is showing.

I know the downward plunge is bad but that's about all I can gather from it.

 

[kent nickell]

Re: Baltic Dry Index; an Economic Indicator

It would definitely seem to be a deflationary move... Things like iron ore aren't moving to China to be turned into more finished products and then these aren't being shipped to the US, etc to be bought by consumers. It seems to reflect decreased demand due to the decreased wealth in the US (decreased stock and home prices and increased unemployment) and also somewhat due to the credit crunch with shipping companies finding it hard to get insurance and lines of credit for their cargos.

This could lead to shortages but that also depends on how big inventories are. If you compare it to the overbuilt home and auto markets then there may be a large glut that needs to be moved through.

But the decreased overall commerce also leads to unemployment and social disruption. Commodities such as food are already at very depressed levels in some places which will probably be further exacerbated by these problems.

I think this is a time to look after basic needs for as many people as possible.
Social safety nets are going to be very important in these difficult times.

 

[JJackson]

Re: Baltic Dry Index; an Economic Indicator

Mixin I would not worry too much about the graph. The site plots all kinds of stuff which investors may find useful in looking for correlations that could guide them as to trends and so aid in making investment decisions. The key is to just look at the the BDI (blue) plot over time which shows the the crash of the the cost of bulk shipping (read Coal & Iron ore to China) which is a proxy for the demand for finished manufactured goods. As your original post points out it is the inelasticity in the bulk carrier stock that makes the BDI such a sensitive barometer. (see also the end section of my post on the Global Conveyer and BDI and the linked LLoyds list article on the letters of credit problem)

I think this is a time to look after basic needs for as many people as possible.
Social safety nets are going to be very important in these difficult times.

I think you are absolutely right. The natural tendency to look after 'number one' and worry less about everyone else needs to be fought hard. I would extend this well outside our national boarders. At times like this the meager progress that has been made in areas like primary health care and safe drinking water (Millennium Development Goals etc.) could very easily be lost and take decades to regain.

 

[mixin]

Re: Baltic Dry Index; an Economic Indicator

Gs has been concerned enough about the economy that he added a subforum for it over at his site. As we add research links to it, I see graphs of just about every kind taking a plunge around July/August.

I keep wondering where was was my head in July and August that I really didn't see this. It's so obvious when I look at the various graphs, it seems like there must have been some big announcement somewhere that I didn't hear.

There are a lot of good research links in gs's Financial Crisis subforum, feel free to take a look. If there's something you want bring over here to discuss, you're more than welcome to do so. http://www.setbb.com/fluwiki2/

 

[kent nickell]

Re: Baltic Dry Index; an Economic Indicator

I first got interested in the problem in February when I came across this editorial in US News and World Report by Mortimer Zuckerman from a few months earlier. Interestingly some of his charitable fund accounts were recently exposed to the Madoff scandal...

Here are some comments I made at the time..

"""I copied this from a recent editorial from US News and World Report. I thought it was an interesting analysis of the mortgage problem... Essentially as you know a lot of sketchy loans were made... And that is just the beginning... Then these loans were sold and resold and used as collateral for complex credit instruments in a game of 'musical chairs'. When the music stopped (home prices started going down) the probems really started and I think are far from over. The president of Merrill Lynch was fired for losing 8 billion dollars from his company in 3 months.. Many personal investors count on companies like Merrill Lynch to act responsibly and when they invest in their products have no idea they are based on such flimsy assumptions where such tremendous losses can be had...

Looks like quite a system of scams. Buying up bad loans, transforming them into complex credit instruments and then passing them on to unwitting consumers as different 'real estate funds'. With far reaching results such as a shakiness in the whole US credit system..."""

http://www.usnews.com/articles/opin...2/a-bumpy-ride-down-the-real-estate-hole.html

Down the Real-Estate Hole
By Mortimer Zuckerman
November 2, 2007

Every time the music stops for a moment, someone loses a seat and everyone howls with laughter. But the game of musical chairs in the financial markets is not very funny. The Merrill Lynch boss loses his seat when the third-quarter losses from mortgage-backed securities turn out to be more like $8 billion instead of the expected $4.5 billion. Merrill Lynch was the largest marketer of these complex financial products. If its estimates are off by around 75 percent, are others far behind? No wonder fear is running in the financial world, to wit, that other banks are also facing dramatic losses, hidden in unbelievably complicated and little understood credit products.

The absence of a market price for these thinly traded securities creates huge leeway on the part of management to decide what they were worth. In one chunk of Merrill's supposedly blue-chip mortgage portfolio, the values were slashed by 57 percent. The Financial Times was on the mark with its metaphor describing the valuation process as "pick a number and divide by the chief trader's golf handicap." More chairs are going to be taken away.

Further down. Worse, the value of the securities is still declining. No one is sure where the losses reside, given that the securities have been sold and resold. What we do know is that people have lost faith in the mathematical models by which these assets were valued?and in the rating agencies that estimated the risk, especially since the rating agencies have downgraded $100 billion of this paper, raising the pressure on an even wider set of financial institutions to declare their losses. When a security goes from AAA to junk within a few weeks, there is bound to be a breakdown in the confidence in the ratings.

Much depends on the U.S. property market. If it continues its slide, it will force even further downward revisions of the assumptions underpinning the original credit ratings. The Wall Street Journal analyzed more than 130 million home loans made over the past decade. It found that the riskiest, high-rate mortgages were made not only to borrowers with sketchy credit or stretched finances but also to those in the middle-class and wealthier communities seeking to buy more expensive homes than their incomes would normally allow. High-rate mortgages accounted for 29 percent of the total last year, up from 16 percent in 2004, and second-lien loans, a way of financing the down payment, climbed to 22 percent?nearly double those in 2004. In one Goldman Sachs securitized offering of mortgages, the average loans, including second liens, were 99.29 percent of the purchases, leaving the average equity invested at 0.71 percent.

Some buyers were just speculating. They lined up for these loans, since essentially none of their money was at risk?meaning they could profit if housing prices rose and walk if they tanked, with little to lose. Last year 13 percent of all high-rate loans were for properties not occupied by owners. Then there's the continuing decline in housing prices, estimated to reach an average of at least 10 percent this year, which will wipe out the equity in many homes and produce an estimated 1.7 million foreclosures next year.

What is to be done? Yes, central banks have been helping by lowering interest rates, but rate cuts address the temporary lack of liquidity and not the degrading of asset quality?which is what threatens a systemic catastrophe.

Congress is jumping in with a bill that prohibits "mortgage originators from steering, counseling, or directing a consumer to any residential mortgage that is not in the consumer's interest." This is legislative nonsense. It's the consumer who has to estimate his future income and the affordability of risk associated with fixed versus adjustable interest rates. Given that financiers have shown they can be wrong about their own investments, how can you make them liable for wrong guesses by the consumers?

I have three suggestions.
? Require loan originators to hold at least a percentage of the mortgages. This would give them a motive for greater diligence; they would have a direct stake in the long-run performance of the loans, and their interests would align with the interests of the investors buying the securities.? The Federal Reserve should look at practices that exacerbated the problem, including excessive penalties for prepayment; the lack of escrow accounts; low-documentation lending; and inadequate borrower repayment standards.
? Investment institutions must find a way to be more transparent in terms of their holdings. A system that disperses risk in such a way that nobody knows who has lost, or how much, is as random in its victims as musical chairs?and a menace to the credit system that lubricates the real economy.

Hold on to your wallets, folks, this is going to be a bumpy ride!