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.

Chinese Inflation: A Mounting Problem

I was asked my views on the Chinese inflation situation today and came up with this short piece:

The Chinese growth story is now sharing the spotlight with the country’s mounting inflation concerns. In January consumer prices rose 7.1%y/y; to a level not seen since 1996, a point when China was in the midst of recovering from levels around 20%y/y. Moreover, based on the current outlook February’s reading is not expected to show any signs of improvement. Starting late January and ending in February China faced a barrage of disastrous winter weather, affecting nearly every aspect of the economy, including crops. This is particularly relevant given that food prices have been the main cause of Chinese inflation, increasing an astonishing 18.2%y/y in January. Important to keep in mind is that January’s reading includes only a small portion of the storm’s total effect, which will be fully reflected in February’s release.

Drilling a bit deeper into China’s inflation problem we look at some of the reasons for the increase in food prices. In part this trend can be attributed to China’s economic success; Chinese economic growth has led to an increase in wealth among its population. With more money to spend Chinese citizens tastes began to shift, in the food sector this meant instead of having vegetables for dinner they preferred meat, especially pork. Since demand for these ‘new’ products are rising faster than they can be supplied, prices are going up. Despite the simplicity of this explanation it could have a significant effect on the Chinese economy. Take this scenario into account; if you expect dinner is going to cost more next month than it did today you are going to ask for better wages to make up the difference. With this in mind inflation expectations have a direct correlation with future inflation based on this principle. Currently, we believe this scenario may already be occurring. Price increases are now showing up in sectors other than food, including services, producer prices, and other non-food products. The increase in service prices could very well imply we are already seeing an increase in the cost of labor due to rising inflation expectations. This scenario will have to be watched closely by Chinese policy makers.

Curtailing the inflation problem will be a tough challenge for Chinese leaders, especially given an increase to inflation expectations. In a more traditional scenario, the solution would simply be a combination of tight monetary policy and conservative fiscal policies. However, a number of problems including reconstruction plans from the winter storms, ‘quasi’ pegged exchange rate, and liquidity factors add up to a unique challenge. Reducing government spending at a time when a large portion of the country’s infrastructure needs to be repaired is not feasible. Additionally, further appreciation of the RMB could reduce exporters’ price advantages to overseas competitors and may reduce Chinese market share lowering economic growth. Finally, increasing rates could make it harder for businesses to borrow within China during a time of industry consolidation; potentially adversely affecting growth. A likely outcome will come by finding a balance between tighter monetary policy and further appreciation in the RMB.