Baltic Dry Index

The Baltic Dry Index, or BDI, is an index of twenty-two key dry bulk shipping rates and is compiled daily in London. This index provides an assessment of the price of moving raw materials such as iron ore, grains, coal, and cement by sea. This index does not include wet goods such as crude oil.

Since this index is not a tradable contract, it does not have a direct speculative component. Although contracts that do contain a speculative component can influence the cost of shipping. One component that has a speculative component, by as much as 30% as this is being written (October 2007), is crude oil. Another is the U.S. Dollar. Since the index is being quoted in dollars, the sharp fall in the dollar is partly responsible for the recent near vertical rise in the index.

So why would an investor or trader care about how much it costs to ship dry goods by sea?

Transportation by sea can be a good barometer of the volume of world trade. This index can be a good economic indicator for future growth and production, since the raw goods being shipped are precursors to production. Also, since the number of ships available is relatively fixed, the price of shipping can go up or down based on supply and demand. If world growth slows, the cost of shipping raw goods will decrease. If world growth accelerates, the cost of shipping raw goods will likely increase.

Today a large portion of the demand for raw goods comes from China. The growth cycle in China influences the profits of many companies around the world. Having an index that can give a clue to when the trend of the demand for raw goods is increasing or decreasing can give important clues to possible changes in broader economic activity.

A century ago the Dow Theory was gaining in popularity, and it is still in use. However, it is much less effective in the new global environment. Part of the Dow Theory requires that a new high in the Dow Jones Industrial Average is to also be confirmed by a new high in the Dow Jones Transportation Average. A failure of both averages to confirm a new high, at least within a reasonable time, would usually imply a potential reversal of trend, to be confirmed by the price action itself. On the other hand, if both averages confirm the new high, the trend is assumed to be intact, and prices can be expected to move higher. The same theory in reverse can be applied to confirmation or non-confirmations of lows, therefore buy signals could be derived from one index making a new low while not confirmed by the other. The basis of this theory is that if goods are manufactured, or raw materials are mined, it is important for the companies that move these goods around the county to also be increasing in value. Using an average of stock prices doesn’t directly measure the cost of transporting these goods, as it does by actually measuring the cost of shipping, but if the transportation companies are making more money, one might infer that there is more transporting activity, and therefore more economic activity in general.

bditrans.png
The chart above shows the Dow Industrials in the upper graph and the Dow Transports in the lower graph. You can see the last high in the Industrials was not confirmed by the Transports. That is the new high only occurred in the Industrials in the upper graph. But if you take the BDI, which is the blue line, into account, the high in the Industrials is confirmed.

Now that the economy has become more global, with China and other emerging markets becoming a more important factor in the world economy, a different type of transportation index is required. The Dow Jones Transportation Average is composed of stocks of companies beyond just the components that transport raw and finished goods. For example, airlines moving people and small packages are also included. While that may indicate current economic activity, it does little to forecast future economic growth in the way raw goods can. Also, much of the activity is domestic, so it does not represent the global picture. While there are some companies represented that deal with global delivery of goods in general, it is quite diluted, and not an accurate measure of the shipment of raw goods. Measuring the actual cost of transporting the raw goods, rather than the value of the stocks of transportation companies, can be a more direct indication of the trend of economic activity. If a transportation average fails to confirm an industrial average at a new high or low, it might be a good idea to also check to see if the BDI is making a more meaningful confirmation.

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The above chart shows the BDI, again as a blue line, overlaid on the Xinhua China 25 ETF, or FXI. There is a very high correlation between the two.

bdifxi.png
The above chart shows the same two price series, but as a weekly chart with the FXI going back to late 2004.

bdiworld.png
The above chart shows the BDI again as a blue line, but this time over the Dow World Index. You can see some leading characteristics in areas where the BDI index tends to accelerate ahead of the Dow World Index. There are a few instances where the BDI falls back and corrections in the World Index follow, although corrections on this chart are very shallow so far.

bdiworldbasicmat.png
Above is a similar chart, but this time with the BDI over the World Basic Materials Index. Since raw goods are the main items being transported, it seems logical that there would be a correlation between the index of basic materials and the cost of shipping them. These two indexes show very high correlation in direction as well as magnitude.

bdicopper.png
Above is the BDI over the continuous NY Copper Futures chart. Here the correlation is a little less obvious. The copper market had a tremendous rally in anticipation of the demand from China. The BDI was a bit behind the acceleration phase of the copper market. As metals prices rise, producers can usually increase production with the result of halting the price escalation. However, demand for copper stayed high at the new higher price. Even rising fuel costs didn’t slow down the demand.

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The above chart with the continuous Light Sweet Crude Oil contract shows much less correlation, as one would expect, since this index is related to shipping dry goods, and crude is obviously not dry.

bdieuro.png
As has been indicated elsewhere in this article, much of the rise in the BDI is a result of the price being quoted in US Dollars, which have been falling. Therefore there is a strong correlation between the Euro Currency and the BDI. There would be an even better correlation between the BDI and the US Dollar Index, but inverse.

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As with the Euro, there is a correlation with the price of gold, but it is not a close as it is to the inverse relationship with the dollar.

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The Ten Year Treasury-Notes (price, not yield) display a fairly close relationship for much of the above chart. One would logically think that higher shipping costs would be inflationary, which would cause yields to rise, therefore Treasury Note prices would fall. But that does not seem to be the case, as can be seen in much of the above chart.

The BDI isn’t always a leading indicator. At times it is coincident, and at times it can lag. It has flaws, as does any index. It can have short term swings that can be more influenced by dollar and oil gyrations. But using the BDI in a longer-term context to view the trend of the cost of shipping can give important clues to the trend in world economic growth or contraction. It can be an important piece of the puzzle to determine longer-term trends in the world economies.

16 thoughts on “Baltic Dry Index

  1. Pingback: Jonathan
  2. John, the data I have is only one price per day. Since this is not really a tradeable item and doesn’t have an open and a close, one settlement price seems to be sufficient. If you have indicators that need all those data fields you just have to use the same price in all fields. On weekly data it would not be a problem.

  3. Excellent Post
    Can u pls tell me which webistes other than
    Dry Ships Inc and Capital Ship Link
    provide BDI data on daily basis?

    Baltic Exchange London Charges for this service! [:(]

  4. BDI, is an index of twenty-two key dry bulk shipping rates and is compiled daily in London.
    So what are the 22 key rates derived, who decides in London and on what basis?

  5. Good afternoon-
    I just recently heard about the Baltic Dry Index in an editorial written by Larry Kudlow, a news brief in Investor’s Business Daily, and a Wall Street Journal article. The take I had was that the most recent report is inidicating a positive movement of product and could be signalling a resurgence economically speaking globally.
    My questions are these: To what extent does this index mirror current economic conditions? Is is a coincidental indicator?
    How reliable an index is it-by that-how much respect is accorded to the index by analysts at Central Banks for example?
    I truly appreciate your commentary on the Index as a first time reader of your website and a stranger to the index this has been most helpful…Thomas Hornish, Economics Teacher/Fed Challenge Advisor

  6. Thomas, I think the Baltic Dry Index at one time was a slightly leading indicator of global economic activity. When I first started following this indicator it was not widely followed, and mostly unknown by the general public. But with the big China boom, along with rising commodity prices, the index gained much media attention and is now much more widely followed. As a result I suspect that it is losing its leading edge, and is probably now more of a coincident indicator. Also, the effectiveness of this indicator assumes the importance of China buying raw commodities as an indicator of global well being. The importance of China can change. Also, the value of the dollar and oil can change the prices of this index, so the index is not purely based on demand. I suspect this index is still being used by central banks and economists in general to monitor global activity, but I don’t have specific knowledge of how, and to what extent, they use this information. But it does give a nice snapshot of the longer term trend of global activity, especially if viewed in a longer time frame perspective. I generally plot a moving average along with the index to better define the trend, as well as a momentum indicator to help indicate when the index is losing steam. I often post examples on my blog. I should post an example in the next day or so.

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  8. What are the units of the BDI? On September 2, 2009 the BDI was at 2,413 – what does this mean in terms of shipping goods, ie what price per metric ton ($/t) does this imply? Thanks.

  9. Alan,
    I would tend to agree. Also, it seems than when any indicator or index gains popular attention, especially when CNBC notices, it will lose some of its effectiveness.
    Doug

  10. Please be advised that the Baltic Dry index is an excellent indicator
    of the health of the world economy and the Dow Jones Transportation Average Index is the same for the USA economy. Using either or both one can become very accurate predicting the near future preformances of stock markets around the world
    if one has the necessay experience.

  11. You should be careful when using words such as ‘correlation’. Just because two lines kinda move in kinda the same direction doesnt tell much about correlation.

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