Dry bulk shipping’s Baltic Dry Index (BDI) has hit new highs for the year.
And once again the BDI’s use as an ‘economic indicator’ is coming out of the woodwork. Past head fakes forgotten.
Raymond James’ J Marshall Adkins asks in a report: ‘Can the Baltic Dry Index Serve as A Leading Indicator of Oil Prices?’
Raymond James: The reason the index is watched so closely by many economists and policymakers is that it is an excellent leading indicator for economic activity. The BDI tracks international carriers hauling raw materials (e.g., wood for Finnish paper mills) as opposed to container ships carrying finished goods (e.g., paper for the U.S. Treasury’s busy printing presses). Thus, the precursors to production, rather than the results of production, are accounted for in the index, giving it a predictive quality. Additionally, the market for these cargo ships tends to be tight and inelastic.
Let’s just first assume that by leading indicator one means ‘reliable leading indicator’ since if it’s not reliable then it’s useless.
Now, there are actually many reasons why the Baltic Dry isn’t a reliable forward indicator for the economy, which we’ve gone into some depth on many times before, yet for the sake of efficiency the following might suffice:
The BDI spiked in 2008 to all-time-highs right before the global economy collapsed. That alone proves it pretty unreliable without getting into the nitty gritty. It’s not an indicator of anything except the highly volatile supply and demand situation between dry bulk ships and commodities at any given moment of time (and with little forward sight). It can change by +/-80% within very tight time frames based on only moderate changes in supply vs. demand, thus turning on a dime even if the economy hasn’t done so.
The supply of ships at any moment has a large impact on the index value. The BDI is a function of supply and demand, and a very sensitive schizophrenic one at that. It’s not just an indicator of demand alone. For example, if massive amounts of new ships flood the market, the BDI will collapse even if commodities demand and the world economy are still growing. This could actually end up being the case over the next two years.
Yet this research piece doesn’t stop at claiming the BDI forecasts the economy alone.
It takes the BDI’s predictive prowess a giant leap further by then suggesting that the BDI might serve as an indicator for oil prices.
Raymond James: It is intuitive that any indicator which gauges worldwide economic activity, such as the BDI, should also give an assessment of global energy prices, since the two are intrinsically tied together. If shipping activity is tied to economic activity, and economic activity is tied to energy prices, then shipping activity should be tied to energy prices. (For you maths majors out there, this is what’s called “transitivity.”) In fact, we’ve found that over the past three years, the BDI and West Texas Intermediate (WTI) oil prices have been closely correlated, as shown in the chart below.
Oil tanker rates don’t even serve as a reliable indicator for oil prices. They can at times fall even while oil prices rise, due to changes in ship supply… so why should dry bulk rates be any better? The effect of ship supply has once again been left out of the above logic.
Yet apparently, this short two-year correlation proves the BDI will reliably forecast oil prices. Just realise how many different charts have had this same shape over the last two years:
(Raymond James, Energy: Stat of The Week, Can the Baltic Dry Index Serve as a Leading Indicator of Oil Prices, J Marshal Adkins, 23 November 2009)
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