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Is this indicator signaling gloom?

Jul 2, 2010

Do you track the GDP and unemployment data coming out of the US? Or the inflation data coming from the government of India? And what about the data on personal income and consumption demand that comes from various economic agencies?

Do you get worried about these pieces of information when they are released? If yes, we must say that you can simply ignore these, as these are mostly outdated facts. Someone telling you in July what happened in May and June must not hold much relevance to how you look at the immediate future.

But there's one data point that's tracked and reported daily. And it's considered one of the leading indicators of economic boom or gloom across the world.

We are talking about the Baltic Dry Index (BDI).

BDI relates to the cost of shipping major raw materials across the world. Materials like iron ore, coal, grain, cement, copper, and fertilizer. The value for the index is determined by the London-based Baltic Exchange. Each day, the exchange surveys shipping brokers around the world for quotes on shipping goods. It then aggregates the quotes to form the BDI.

So you may ask - Why is the BDI significant?

Well, BDI holds tremendous relevance as it signifies the level of trade that's happening across the globe. Trade between Australia and China, between India and Africa, between Europe and Japan, or between the US and Middle East. And given that it tracks the cost of shipping raw materials, which determine the level of industrial production and consumption, it provides an exact measurement of the volume of global trade at the earliest possible stage.

And what is the BDI hinting at currently? See this.

Baltic dry index a warning signal
Data Source: GE Shipping, Businessweek

We know for the fact that the turmoil in Europe has been going on for some time now. And that the US itself is facing severe economic pressures. But despite that, the BDI was on a rise between February and May 2010. And then, in a span of just a month, it has crashed by nearly 42%.

So, what's going on that has made this index drop so sharply in such a short time?

Call it the 'China effect'!

With China trying to slow down to avoid economic bubbles from building up, it has reduced its demand for commodities, In fact, as per its customs data, China's imports of coal and iron ore fell in April and May and are looking to fall further. The country's manufacturing growth has already slowdown. And the fall in BDI indicates that the slowdown will continue in the immediate future as well.

As per industry experts, coal and iron ore, which are raw materials to make steel or generate power, account for over 50% of all dry-bulk goods carried at sea. So with China cutting back on its intake of these materials, the demand for shipping and thus the BDI have taken a severe hit. Economists are also expecting an appreciation of the Chinese Yuan to impact the BDI further.

This is considering that an expensive Yuan will make exports out of China expensive for buyers in the US and Europe. This will potentially reduce demand for Chinese exports. And the BDI is pointing to that already!

A Chinese slowdown could be bad for commodity suppliers around the world. And that includes Indian commodity companies as well. However, lower commodity prices would be good for consumer industries like automobiles here.

So, watch out for the BDI. It might just help you in assessing the risks the economic recovery faces!

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1 Responses to "Is this indicator signaling gloom?"

Mandar Apte

Jul 2, 2010

Although what is said is agreeable, BDI has a history of wild swings.
Question is whether it can be reliably extrapolated to assess the future course of markets and economy.

Equitymaster requests your view! Post a comment on "Is this indicator signaling gloom?". Click here!

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