The Baltic Dry Index is a daily average of prices to ship raw materials. It represents the cost paid by an end customer to have a shipping company transport raw materials across seas on the Baltic Exchange, the global marketplace for brokering shipping contracts. The Baltic is owned and operated by the member buyers and sellers. The exchange maintains prices on several routes for different cargoes and then publishes its own index, the BDI, as a summary of the entire dry bulk shipping market. This index can be used as an overall economic indicator as it shows where end prices are heading for items that use the raw materials that are shipped in dry bulk.
Why Investors Watch the Baltic Dry Index
The BDI is one of the purest leading indicators of economic activity. It measures the demand to move raw materials and precursors to production, as well as the supply of ships available to move this cargo. Consumer spending and other economic indicators are backward looking, meaning they examine what has already occurred. The BDI offers a real time glimpse at global raw material and infrastructure demand. Unlike stock and commodities markets, the Baltic Dry Index is totally devoid of speculative players. The trading is limited only to the member companies, and the only relevant parties securing contracts are those who have actual cargo to move and those who have the ships to move it.
Typically, demand for commodities and raw goods increases when global economies are growing. For investors, knowing when the global economy is growing is helpful because that means stock prices, commodity prices and the value of commodity-based currencies should be increasing. Conversely, demand for commodities and raw goods decreases when global economies are stalling or contracting. For investors, knowing when the global economy is contracting is helpful because that means stock prices, commodity prices and the value of commodity-based currencies should be decreasing.
The Baltic Dry Index is also a compelling indicator because it is a simple, real-time indicator that is difficult to manipulate. Some economic indicators—like unemployment rates, inflation indexes and oil prices—can be difficult to interpret because they can be manipulated or influenced by governments, speculators and other key players. The Baltic Dry Index, on the other hand, is difficult to manipulate because it is driven by clear forces of supply and demand.
The supply that affects the Baltic Dry Index is the supply of ships available to move materials around the globe. It is difficult to manipulate or distort this supply because it takes years to build a new ship that could be put into service to increase supply, and it would cost far too much to leave ships empty in an attempt to decrease supply. The demand that affects the Baltic Dry Index is the demand of commodity buyers who need the raw goods for production. It is difficult to manipulate or distort demand because it is calculated solely by those who have placed orders to have raw goods shipped. Nobody is going to pay to book a Capemax cargo ship who isn't actually going to use it.
What caused the crash?
There are two problems:
Producers are stuck with huge inventories. Post the collapse of commodity prices, no one is in hurry to build inventories. Also, with production cuts and factory shut downs, existing inventories have become a huge issue.
Credit Crisis: No one wants to lend in current market environment. As a result, Letters of credit are not getting issued. They are required to load cargoes for departure at ports. One analyst described it pretty well – “If I can’t get credit to get iron ore shipped to me today, then I’m not buying iron ore — and “demand” has dropped”
This is unprecedented and unusual situation.Keep an eye on BDI index. Movements in the Baltic Index tend to precede movements in global stock markets. (Remember BDI is termed a leading economic indicator because it predicts future economic activity.)
What is the current Scenario?
From the BDI 3 year charts as on 9th April 2009 shows that the leading economy indicator dipping at a faster rate from its recent high. But markets are making out breakout and rallying. Huh!!! Stock Markets are really crazy in this world.