The Baltic Dry Index (BDI): Can it tell us anything?

BDI Revisited in new entry written 11/08/2008

Globalization and world trade has become the major growth force in emerging market economies and has significantly influenced developed nations as well. The big question is; how or has the US led slowdown affected this trend. There are of course a series of indicators we can look at to determine the size and value of international trade. But for this analysis we are going to take a look at a less discussed indicator, the Baltic Dry Index.

The BDI is showing a bit of a recovery

What is the Baltic Dry Index (BDI)?
To put it simply, the BDI is a daily index which tracks the shipping costs by sea for various materials including metals, grains, oil, etc...

Why we think it is important?
You can't just build a new cargo ship... When demand for shipping goes up and the supply of boats remains constant prices will go up. Hence we can use the BDI index as a gauge for the demand of shipping and a proxy for the level of international trade. In fact looking back on the data we can see a high correlation between global trade and the BDI. Keep in mind other factors such as oil prices can affect the BDI, but at the same time shipping companies can mitigate these effects by hedging and reducing speeds to conserve fuel.

Most importantly the BDI is a daily index, so we can track demand in the shipping industry in real-time. So if the slowdown is affecting global trade we will see it now not later, and a change in demand for exports could have huge impacts on a lot of economies.

What is the BDI telling us now?
The BDI reached unprecedented levels in 2007, corresponding with the rise in international trade. However, we have recently seen a decline starting in December of 2007, corresponding to the slowdown in the US. The positive news is that it appears the BDI bottomed on Jan. 29th 2008 at 5,615, and is staging a bit of a recovery now at 7,993 verses it high of 11,039 in October. Although it is tough to say how much of this is could be oil related.

Interesting to note is that Canada experienced an 8.5% drop in exports in 4Q07; Canada is the US's largest trading partner. Australia also saw a weakening of exports during the same period.

Conclusion:
We do believe global trade is being affected by the US led slowdown, and that this indicated by the BDI index. The good news is since the BDI is that since it is a daily index we can get a real time idea of what the slowdown could mean to global trade. The bottom line is we think that in this day and age the BDI is an index which should get more attention despite its imperfections.

There is a significant correlation between the qoq change in US (imports +exports) and the BDI...

ADDED LATER:

We wanted to look at the relationship between the BDI and an ETF of natural resources companies, since this industry would make significant use of international freight shipments. However, we could not find a suitable ETF, so we used the equity price of BHP Billiton. The results were not surprising. As expected there was a significant relationship between the stock price and the index. To us this suggests the BDI is heavily influenced by raw commodities exports (which makes sense), and provides an excellent gauge for the global demand of raw commodities.

The BDI has a significant positive relationship with the EQ price of BHP.

Does the Federal Reserve Board's Senior Loan Officer Survey imply anything for growth?

*I believe so and this is why... (A quick synopsis)
http://www.federalreserve.gov/boarddocs/snloansurvey/

Looking at the trend from the past several Senior Loan Officer Surveys, we have seen lending standards for banks and consumers tighten, while demand has receded and spreads of loan rates verse the banks' cost of funds are rising. We expect when the next wave of data is released during the first week of Feb. we will see further deterioration. But what does this mean?

The survey is released on a quarterly basis, and the senior loan officers answer the questions during the first month of the applicable quarter. (i.e. Q108 data is collected during Jan. 2008) This more or less implies the data has a built in lag, since the quarter has only begun when the data is collected.

Now on to the good stuff...
After running numerous basic OLS regressions comparing the Senior Loan Officer Survey with the applicable quarters real GDP data, we found that some portions of the Senior Loan Officer survey are in fact correlated with that quarter's real GDP growth and its sub components.


Non-residential Investment:
We found that the strongest relationship exists between non-residential investment and the data in the survey related to the the number of banks tightening lending standards to businesses , businesses' demand for lending, and the cost of lending.. In fact, the correlation between this data and non-residential investment is strong enough to pass-through to overall real GDP growth, but as you would expect with a smaller magnitude. We found that the reason for the relationship is because the level of business lending drops when costs and lending standards increase and demand drops, all of which are measured in the survey.

Business lending related questions from survey:
1. Net Percentage of Domestic Respondents Tightening Standards for C&I Loans
2. Net Percentage of Domestic Respondents Increasing Spreads of Loan Rates over Banks' Cost of Funds
3. Net Percentage of Domestic Respondents Reporting Stronger Demand for C&I Loans


Residential Investment:
We also found that the lending standards and demand for mortgages data is correlated with residential investment, although not at the same significance as business lending with non-residential investment. We found the strongest result between residential mortgage demand and residential investment, but unlike the non-residential relationship it was not strong enough to pass-through to overall real GDP growth.

Residential mortgage related questions from survey:
1. Net Percentage of Domestic Respondents Tightening Standards for Mortgage Loans
2. Net Percentage of Domestic Respondents Reporting Stronger Demand for Mortgage Loans


Personal Consumption Expenditure:
Unfortunately, we did not find any significant relationships..

Consumer spending related questions from survey:
1. Net Percentage of Domestic Respondents Tightening Standards on Consumer Loans
2. Net Percentage of Domestic Respondents Reporting Increased Willingness to Make Consumer Installment Loans
3. Net Percentage of Domestic Respondents Reporting Stronger Demand for Consumer Loans


What does it all mean?
To me this implies that further deterioration in the Q108 Senior Loan Officer Survey could increase the downside risk to Q1 growth, especially via the non-residential investment component. At the same time, where the survey results to improve we would expect the opposite, but given the current trend in the data, a positive report would surprise us.

Topic revisited in 11/3/08 piece