You could make a fortune if you knew the trajectory of global growth. For instance, you can pretty much write in stone that US treasuries will perform well when global growth contracts. Flip to stronger growth, and an investment in commodities and/or their producers would usually be lucrative. There is a well-worn indicator often used to predict the direction of global growth. It’s called the Baltic Dry Index (BDI).
In this piece we explain the workings of the BDI, explore its recent weakness, and conclude with a few thoughts on whether it remains a relevant indicator.
The Baltic Exchange published the first daily freight rate – the series of which is today called the BDI – in January of 1985. To calculate it, shipping brokers from around the globe submit their contracted shipping rates across 22 major shipping routes, for three different vessel types; Capesize, Panamax, and Supramax. That data is collated into an index.
The purpose of creating this index was to grease the gears of the shipping industry. With one price, people wanting to transport raw materials didn’t need to spend an inordinate amount of time getting quotes to avoid being ripped off. The index soon tickled the fancy of not only those interested in booking seaborne freight, but also of individuals shipping nothing at all.
Capesize shipping vessel (Source: www.gcaptain.com)
The BDI is a coincident indicator. This means the numeric daily figure published is a real time snapshot of shipping activity, and by extension, the global demand for raw materials. What’s more, it’s an index difficult to manipulate; the price discovery that informs the daily freight rate only materialises on the back of actual shipping orders.
And because the raw materials being shipped must chronologically forerun the final products they help build, the BDI gives you a glimpse into what future economic activity might look like. After all, construction companies don’t order cement without a bridge to build, a skyscraper to stack, or a dam to dam.
This hard data piqued the interest of investors looking for a steer on global growth. Whereas many of their other ‘trusty’ indicators were/are vulnerable to speculation, the BDI offered them an almost incorruptible piece of information they could stand behind. But as the index rose in prominence amongst investors during the 2000’s, there was something playing out that would undermine its power.
It’s useful to understand the history of the BDI to contextualise the recent collapse. The Chinese-driven commodity super-cycle that took place between 2002 and 2008 saw demand for raw materials increase in spectacular fashion. More ships were needed to ferry the coal, iron ore, cement, grain and fertilizer necessary to industrialise China.
Ship builders duly obliged. But because these monstrous vessels take a few years to build, many of their propellers felt torque, for the first time, in a post-commodity-super-cycle world; the world fleet of dry bulk vessels doubled between 2010-2013.
To demonstrate the extent of the frothiness caused by the super-cycle, consider the following: The US dollar rate for a Capesize ship – named as such because it’s too big for the Panama Canal and must travel around either Cape Horn or the Cape of Good Hope – was set at $250,000 per day in early 2008. Fast forward to the beginning of February 2020, and that daily rate sits below $4,000. That is dangerously close – if not there already – to loss making levels for ship owners.
These are two arbitrary points in time, but since 2008 there has been a clear structural decline in shipping prices as a result of an unfavourable supply/demand dynamic brought on by ship builder exuberance during the super-cycle. This is clearly illustrated in the chart below which plots the BDI since 1998.
The lifespan of these ocean giants is anything between 15-25 years, so it might be a while yet before ship owners regain pricing power. Until then, undercutting the competition on pricing could continue to underpin a structural decline of the BDI. You may have noticed the recent, precipitous fall of the index. In magnitude, this move is only second to the fall that preceded the GFC.
Source: INet, Obsidian Captial, February 2020
For those following the BDI to get a feel for the trajectory of global growth, the recent price action looks frightening. After hitting a high just north of 2,500 in September 2019, it has plummeted to 434 at the time this was penned. Outside of excess capacity, there are at least three other culprits responsible for this collapse.
First, in October of 2019, Donald Trump announced that a ‘Phase 1’ agreement with China had been agreed upon in principle. Until this turning point, the rhetoric from both parties suggested more tariffs to come.
With the threat of higher prices down the road (due to tariffs), it’s very possible that procurement functions around the world ratcheted up their raw materials purchases to save money. With that threat abating, the urgency to order ahead of tariffs may have waned, weighing on shipping activity and the BDI.
Second, the Chinese economy has grown to such an extent that they are now responsible for a large chunk of shipping freight.
Scroll back to the chart and look at the behaviour of the index every January/February since 2010; it falls without exception.
This is predominantly due to the seasonal cessation of economic activity in China as they celebrate their New Year. This has undoubtably come into play again in early 2020.
Finally, the spread of the Coronavirus has extended and amplified said seasonal economic shutdown in China, affecting both inbound and outbound shipping. Given the size of their economy and its influence on global growth, this remains a very concerning development, and one that might be responsible for most of the recent damage we have seen in the Baltic Dry Index.
The recent BDI price action looks like a death knell for global growth. But there are certainly once off/seasonal factors that have exacerbated the pullback of this tried and tested indicator. How worried should we be? Is this bellwether still clairvoyant in character? Directionally, we think the BDI is still a valuable indicator to consult in building a mosaic around the trajectory of global growth. But it shouldn’t be used in isolation.
China, while still a very large component of commodity demand, is in the process of transitioning to a consumer economy, rather than one driven by industrialisation. As such, their consumption for raw materials is perhaps not as dictatorial to the global business cycle as it used to be.
The excessive supply of shipping vessels also means that price discovery, reflected in the BDI, is not as efficient as it once was; the desperation of a few empty ships could easily distort prices. Perhaps we need to lose a few of these monstrous vessels to Davy Jones’ Locker before the Baltic Dry Index regains its power to once more foretell the direction of global growth. Until then, use the BDI to help you navigate the global growth question, but don’t make it your North Star.