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The holy grail of obscure indicators loses its lustre

The Baltic Dry index has lost its cool. And it's going to have to jump over an awful lot of freighters to get it back.

The index – which tracks global freight prices for shipping dry bulk commodities such as coal, grains and iron ore – remains mired in its lowest trading range in more than 25 years. After showing some encouraging gains since early June, the Baltic Dry has once again gone into a skid, slumping 6 per cent in a week.

Historically, a weak Baltic Dry was a canary in the coal mine – a warning that commodity demand was in trouble, that the global economy was ailing and that financial markets were about to take a turn for the worse. For astute market watchers, it was the holy grail of obscure indicators.

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But its latest drop may signal nothing. Changes in the global shipping business over the past few years have made the Baltic Dry irrelevant.

Too many ships

Since the 2008-2009 recession, the previously close correlation between the Baltic Dry index and dry bulk commodities has fallen apart. So far this year, the Baltic Dry has tumbled nearly 40 per cent, even as grain prices have spiked, iron ore prices have risen, and commodities overall have posted little change.

This is because shipping costs, which are traditionally a function by commodity demand, have in recent years become dominated instead by issues of shipping supply. A surge in orders for new ships at the commodity market's peak in 2008 has led to a flood of new cargo capacity since 2010. (It takes a few years for big freighters to be built and go into service.)

"Demand for shipping has rebounded from its late-2008 lows, but capacity has been rising even faster, causing utilization rates and hence shipping costs to plummet," said Julian Jessop, chief global economist at Capital Economics. "Order books for delivery in 2012 suggest that this year will see a further surge in supply, maintaining the downward pressure on prices."

Look to short term

The Baltic Dry has diverged from the stock market over the past couple of years, too – a sign that its usefulness as a barometer of the broader underlying economic trend has also waned. Yet over the past few months, the stock and shipping index have exhibited similar trends.

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"The supply of shipping is less volatile than demand, meaning that over shorter periods, the [Baltic Dry] should still be a good indicator of the health of the global economy," Mr. Jessop said.

The idea is that while changes in freight capacity may be driving a longer-term re-pricing of freight, it's still the demand swings that drive shorter-term price fluctuations. The recent drop in the Baltic Dry, then, could indicate that current demand doesn't support the recent rebounds in stocks and commodities.

Over the longer term, though, we're going to need freight capacity to stabilize before the Baltic Dry can regain its cachet.

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