Friday, December 18, 2015

Can the Baltic Dry Index (BDI) be used as a crystal ball?

This year, the Baltic Dry Index (BDI) or BIFFEX, as some of us involved in its creation still call it, celebrates 30 years of existence. The BDI, which is nothing more nothing less than a weighted price index of dry bulk freight rates, was created as a hedging instrument: by taking long or short positions in a futures paper market, traders (shipowners and charterers) can partially hedge actual physical market risk. And although the BDI has never fully achieved this objective, having been scorned often by risk-prone shipowners, it nevertheless offers us a long series of prices, which is most useful in business cycle analysis. 

But could BDI be used as a leading or lagging indicator of economic activity? Let’s have a look at the graph which, together with BDI (yellow line), presents the Goldman Sachs Commodity Index (GSCI) (blue line). Observe the high correlation in the 5-year period 1997-2002. What is more interesting however is that the BDI envelops, as we say, the GSCI throughout this period. In other words, during an economic downturn, BDI is a leading indicator of economic activity. Or, to put it differently, freight rates are good leading indicators of oncoming recessions. The opposite is true in a rising economy: by looking at commodity markets, one could (carefully…) take a view on shipping developments and expectations, particularly as regards newbuilding investment timing; sale & purchase; and chartering decisions; i.e. short (spot) or long (time) charters. (Apologies to my shipowning friends for revealing their secrets…). HH