By Doug Tucker
The Baltic Dry Index, or BDI, is an index of twenty-two key dry bulk shipping rates and is compiled daily in London. This index provides an assessment of the price of moving raw materials such as iron ore, grains, coal, and cement by sea. This index does not include wet goods such as crude oil.
Since this index is not a tradable contract, it does not have a direct speculative component. Although contracts that do contain a speculative component can influence the cost of shipping. One component that has a speculative component, by as much as 30% as this is being written (October 2007), is crude oil. Another is the U.S. Dollar. Since the index is being quoted in dollars, the sharp fall in the dollar is partly responsible for the recent near vertical rise in the index.
So why would an investor or trader care about how much it costs to ship dry goods by sea?
Transportation by sea can be a good barometer of the volume of world trade. This index can be a good economic indicator for future growth and production, since the raw goods being shipped are precursors to production. Also, since the number of ships available is relatively fixed, the price of shipping can go up or down based on supply and demand. If world growth slows, the cost of shipping raw goods will decrease. If world growth accelerates, the cost of shipping raw goods will likely increase.
Today a large portion of the demand for raw goods comes from China. The growth cycle in China influences the profits of many companies around the world. Having an index that can give a clue to when the trend of the demand for raw goods is increasing or decreasing can give important clues to possible changes in broader economic activity.
A century ago the Dow Theory was gaining in popularity, and it is still in use. However, it is much less effective in the new global environment. Part of the Dow Theory requires that a new high in the Dow Jones Industrial Average is to also be confirmed by a new high in the Dow Jones Transportation Average. A failure of both averages to confirm a new high, at least within a reasonable time, would usually imply a potential reversal of trend, to be confirmed by the price action itself. On the other hand, if both averages confirm the new high, the trend is assumed to be intact, and prices can be expected to move higher. The same theory in reverse can be applied to confirmation or non-confirmations of lows, therefore buy signals could be derived from one index making a new low while not confirmed by the other. The basis of this theory is that if goods are manufactured, or raw materials are mined, it is important for the companies that move these goods around the county to also be increasing in value. Using an average of stock prices doesn't directly measure the cost of transporting these goods, as it does by actually measuring the cost of shipping, but if the transportation companies are making more money, one might infer that there is more transporting activity, and therefore more economic activity in general.
Now that the economy has become more global, with China and other emerging markets becoming a more important factor in the world economy, a different type of transportation index is required. The Dow Jones Transportation Average is composed of stocks of companies beyond just the components that transport raw and finished goods. For example, airlines moving people and small packages are also included. While that may indicate current economic activity, it does little to forecast future economic growth in the way raw goods can. Also, much of the activity is domestic, so it does not represent the global picture. While there are some companies represented that deal with global delivery of goods in general, it is quite diluted, and not an accurate measure of the shipment of raw goods. Measuring the actual cost of transporting the raw goods, rather than the value of the stocks of transportation companies, can be a more direct indication of the trend of economic activity. If a transportation average fails to confirm an industrial average at a new high or low, it might be a good idea to also check to see if the BDI is making a more meaningful confirmation.
The BDI isn't always a leading indicator. At times it is coincident, and at times it can lag. It has flaws, as does any index. It can have short term swings that can be more influenced by dollar and oil gyrations. But using the BDI in a longer-term context to view the trend of the cost of shipping can give important clues to the trend in world economic growth or contraction. It can be an important piece of the puzzle to determine longer-term trends in the world economies.
Click on the link in the resource box to view many charts of the BDI as it correlates with other indexes.
Doug Tucker has a blog with daily commentary on stock indexes, precious metals, and other markets. There are many articles on technical analysis and indicator design and interpretation. To visit go to: http://tuckerreport.com/
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