What the Baltic Dry Index might be telling us, by Harold AGJ Davis

Is the global economy about to pass through the worst and set the stage for recovery? One interpretation of the Baltic Dry Freight Index suggests that, at least, the maritime shipping crisis is bottoming and recovery could begin to gradually build. Given that shipping problems reflect many of the same behaviours and fundamentals as the world economy; this may indicate that global growth will resurge and accelerate in 2017. 

As a quick refresher, the London based Baltic Exchange publishes the Baltic Dry Index as a measure of sea-borne freight rates on 23 major international maritime shipping routes, not simply Baltic Sea destinations. The BDI covers Handysize, Panamax and Capesize dry bulk carriers conveying basic raw materials such as grains and oilseeds, coal, iron ore, etc. In brief, it is the most widely followed measure of the price of moving commodities by sea. 

The importance of the BDI to forecasters rests upon the notion that orders for and the movement of raw materials must precede manufacturing, industrial activity and finished goods shipments that eventually become consumer purchases. Thus, the BDI and raw material prices are considered leading indicators of GNP. However, shipping rates also have their own fundamentals.

 In recent years, shipping magnates made many of the same mistakes as industrialists. The cost of capital was so low for so long, the global shipping fleet was over-built and there is now surplus capacity. Old and obsolete capacity must be retired, but the situation is not so simple. Faced with low scrap metal prices, owners of old ships which are fully depreciated and entirely paid for can run profitably as long as they recover variable and operating costs.

Surplus capacity has lingered and absorption has been slow. This echoes the weakness in manufacturing capacity utilization around the world. So, now that the Baltic has started building a bottom on the charts, it is noteworthy.

Dating back to the 2008 economic collapse when the Baltic Dry Index plunged in value from above 11,500 down towards 600, the 650-550 range has been considered major underlying support. Yet, a few months ago, the BDI broke support and slumped unbelievably towards 300. The pulling of hair, gnashing of teeth and rending of garments gave vent to the despair. 

However, to chartists fond of plotting curved accelerations and decelerations, an internal momentum curve dating back to about May 2010 and touching points in October 2011, lows in August 2013, July 2014, February 2015 and 2016 strongly suggests that the obvious break in support was  `false`.

In fact, the break below horizontal support was entirely consistent with a decelerating bear market that has progressed from declining to flat and now arrived at neutral. The old curvilinear declining tops line has become the new underlying bottoms line. This major bear market looks dead, but prices often linger near low levels long enough to cause damage.

The fundamental suggestion of this trend changeover and slow bottoming is that 2016 will be the year of the scrap heap, the breaker’s yard, and the distress sale. Hard decisions will have to be made and surplus capacity on land and sea will progressively be absorbed or dismantled. Of course this capitulation will have a profound impact on other entities such as suppliers and bankers, and even capital markets. However, these acts of creative destruction will finally clear the way for new ventures and technologies that will power the next technological generation of recovery for years to come. 

For the time being, expect markets to be preoccupied with the pulling of hair. However, at some point later this year, pay attention to corporate survivors, bright new ideas and recognize that the ensuing recovery will probably generate higher interest rates in 2017. 

Harold AGJ Davis is the Author and Analyst at www.prairiecropcharts.com