A quirky canary-in-the-coal-mine indicator for global economic activity is in freefall, but market experts can’t agree on whether it’s a sign of danger or an accident of recent history on the high seas.
The Baltic Dry Index – an index of global freight rates for shipping dry commodities such as iron ore, coal and grain – had fallen for 23 consecutive days as of last Friday, cutting its value in half in the space of a month. The last time the index was this low, the world was in the depths of a credit crisis and a major recession.
While the Baltic Dry Index is obscure to your average retail investor, keen market watchers have long considered it a valuable leading indicator for the world economy, indicating shifting tides in demand for key industrial commodities. And its plunge comes at a time when the prices for many key commodities remain buoyant – a disconnect that would traditionally suggest that commodities are poised for a fall.
But this time around, the Baltic Dry may not be signalling a slump in demand, as much as the growing supply of ships to carry them.
“A few years ago, there was a big shortage of these large ships, and the [Baltic Dry]Index soared,” said Ed Yardeni, president and chief investment strategist at U.S.-based Yardeni Research Inc. The response to the soaring freight prices was for shipping companies to order new vessels from shipbuilders – orders that were placed before the 2008-09 recession that hammered shipping rates. But because of the lengthy manufacturing cycle for large freighters, many of those ships are only now being delivered.
“Now, we have a glut of capacity for these commodities,” he said.
Peter Hall, chief economist at Export Development Canada, said global dry-bulk shipping capacity jumped 10 per cent in the last six months of 2011 – a time when shipping disruptions from the Japanese earthquake and the Arab world’s unrest, as well as a slowing in China’s industrial activity, constrained demand. That has taken a major toll on shipping rates, and the Baltic Dry Index.
He said forecasts are for the shipping capacity to grow by another 7 per cent in 2012 – a pace that even a booming global economy would have trouble matching.
“We could have a pickup in global demand and still not see improvement in the index, because of all these ships,” he said. As a result, he argued, “This is not a good barometer of the global economy.”
“I’d be wary about reading too much into this [fall of the Baltic Dry Index]” said Julian Jessop, chief global economist at Capital Economics in London. “The weakness … is probably telling us a lot more about the shipping industry than the commodities market or the global economy. In any event, there are many other more reliable leading indicators of global demand, such as the purchasing managers surveys.”
But some economists nevertheless are concerned that the steep and sudden tumble in the Baltic Dry Index is evidence of evaporating demand. They say it could be a sign that China – a key customer of dry-bulk goods, and notoriously unpredictable in its purchasing patterns – is stepping back from the market in a big way. If so, they said, its economy could be slowing faster than many experts think.
“We know that China has slowed down; the question is, how much?” said BMO Nesbitt Burns senior economist Jennifer Lee. “It is a little worrying, and something to keep an eye on.”