By SIMON CONSTABLE
News that the Baltic Dry Index is sunk as an economic indicator is much exaggerated.
The index—which measures the cost to haul dry freight over the world's oceans—has merely run aground after getting hit with a shipping-market tsunami. Don't worry. It will right itself soon enough–and should once again become a useful forecasting tool, as early as the end of the year.
The cost of shipping dry commodities, such as coal, iron ore and grains, forms the basis for the BDI. When more raw materials are shipped, it is because they are needed to be made into finished products. Also, when more of them are shipped, the price of chartering a vessel increases. That makes the index a gauge of industrial expansion.
It worked beautifully until the financial crisis. Then things went wrong.
Since November 2009, the BDI has plunged 85%, from a high of 4661 to 715 Friday. Normally, such a move would augur a global slump. But this time, the slide coincided with the recovery, albeit a slow one, from the 2008-2009 global recession. That mismatch has some people willing to forever scuttle the idea of the BDI as an economic indicator.
The truth is those problems are only temporary.
What really happened was a "massive oversupply of ships that skewed the index," says Natasha Boyden, director of maritime equity research at Cantor Fitzgerald in New York. Data from Jefferies & Co. show that the global fleet of dry-haul ships grew over 10% in both 2010 and 2011, powered by some overly optimistic ship-building orders placed prior to the 2008 downturn. In addition, a Chinese government initiative to keep its shipyards humming further flooded the market with vessels.
WITH ALL THE EXTRA SHIPS hitting the water, charter rates dropped precipitously to multi-decade lows. For example, a panamax—or midsize–vessel that fetched around $32,000 a day in late 2009, now gets a mere $6,600 a day, a hair above its $6,000 operating cost, according to Clarkson Capital Markets.
A poor economic situation for shipping companies to be sure, but it hasn't permanently damaged the BDI as an indicator. Good news: The glut of ships is about to end. Specifically, the number of vessels hitting the water will slow in 2012's second half, according to Douglas Mavrinac, managing director at Jefferies in Houston. He says that the growth-rate trend for the bulk-carrying business is around 6% a year, but the expansion of the global fleet is falling, to around 4% next year.
More important, Mavrinac sees the demand for ships and the number available aligning by year-end, or thereabouts. When that happens, too many ships will no longer be bidding for too few cargoes. That equilibrium will be the tipping point–and will restore the BDI to its former luster as an indicator of commodities demand. The trick for investors is not to look at the level of the index, but rather the trend. A rising trend is bullish regardless of the level; declines are bearish.
Investors should also keep an eye out for any irrational exuberance in ship building.
Link to Barrons.com.