Dry spell – Why the Baltic Dry index is not the reliable macro indicator some believe it to be
How much excitement is there to be found in that part of the financial world where shipping and raw materials converge? If you barely made it to the end of that sentence with your eyes open then clearly you are unaware of the sort of frenzy some commentators can work themselves up into over the Baltic Dry index.
This is essentially an amalgamation of 20 or so different shipping routes for four sizes of ‘dry-bulk’ carriers – ships that transport a range of commodities such as grain, coal, iron ore and other metals. What those commentators believe is that the Baltic Dry index can be used as an indicator of the health of the global economy.
The theory goes that the index can foreshadow where the economy is heading because it shows whether real trade is picking up or shrinking around the world. A greater number of learned articles than you might suppose get written on this subject, complete with charts such as the one below from website Zero Hedge, that appear to support the idea.
Baltic Dry Index
G10 is a macro economic indicator used by Zero Hedge in the article to describe the macroeconomic condition of the G10 countries.
Source: Bloomberg as at January 2014.
The problem is, the movements in the Baltic Dry index that so excite those commentators often have very little to do with world trade. Dry-bulk shipping is actually one of the most volatile commodities in the world – a point neatly illustrated by the right-hand half of the chart – yet some took its steep rise last November as pointing to a pick-up in the global recovery.
In reality, however, it was pointing to a meteorological idiosyncrasy – specifically, an unusually wet summer in Brazil. Among the biggest users of dry-bulk shipping are businesses exporting iron ore from Brazil to China. When dry, iron ore is easily – and safely – transported by sea but, if it gets wet, it tends to slosh around its container, leaving the ship carrying it in serious danger of capsizing.
Last summer thus saw very little iron ore exported from Brazil but, as soon as the rain stopped, there was a huge pick-up in demand for dry-bulk carriers to ship the stockpiled metal to China – and so the Baltic Dry shot up. So does the fact the index has now experienced its largest fall since 2008 mean we should be panicking about an economic contraction or can we find another idiosyncratic explanation?
How about environmental law in Latin America? Colombia, one of the world’s largest exporters of coal, recently tightened up its rules on ship-loading and, at least for the time being, some of the bigger coal-shipping businesses operating out of the country have found themselves unable to comply and thus without licences to ship coal. Cue a huge fall in the Baltic Dry index.
What we have here, of course, is another example of the dangers of confusing causation and correlation, which we also considered in Killer question. People may get worked up about the Baltic Dry index as a powerful macroeconomic indicator but it is really just an aggregation of lots of individual shipping contracts.
As such, economic factors will clearly have an effect but so will plenty of other things. So yes, at times, the Baltic Dry index may well move broadly in line with the global economy but, over the short term, economic influences can be massively outweighed by idiosyncrasies in the market – be that poor weather in Brazil, environmental regulations in Colombia or whatever the fates next have in store.
Fund Manager, Equity Value
I joined Schroders European equity research team in 2007 as an analyst specialising in automobiles. After two years I added the insurance sector to my coverage. In early 2010 I moved into a fund management role, and then took over management of two offshore funds investing in European and Global companies seeking to offer income and capital growth.
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