Baltic Dry turns wet blanket

It sounds like a Lithuanian weather report, but The Baltic Dry index is more of a forecast for the global economy than a predictor of rain in Vilnius.

Issued by Londons Baltic Exchange (itself named after the Virginia and Baltick coffee house in 18th Century London) the BDI is a somewhat obscureindicator that some see as the best gauge of the global economy.

Every day, the Baltic Exchange canvasses shippersthroughout the globe to see what the going rates are tomovevast quantities of raw materials across large distances.

The exchange figures out what it costs to send a Panamax boat full of Australian coal to China, for example, or Chilean copper to South Korea, and contrasts those prices with what they were the day before.

The exchange then compiles all the data into the BDI and expresses it as a number. Today, for example, its sitting at 974. Is that good? Is that bad? As the chart above shows, it depends on your perspective.

For decades, the BDI was seen as one of the best leading indicators, because it was a real-world gauge of the industrial production that makes the worlds economy run.

Shippers dont order 150,000 tonnes of lumber shipped halfway around the globe unless theyre certain they need it to meet demand for finished products down the line. So a healthy demand for shipping indicates strong consumer spending in the near future, or so the theory goes.

That certainly held true in the past, as the BDI showed an uncanny knack of predicting economic slowdowns before politicians and the general public saw them coming.

After hovering just below the 2,000 level for years, the index went positively haywire in the mid 2000s, peaking atmore than 11,000in 2008. That should have meant good times were coming, not the global economic slowdown that followed.

Supply glut

It seems afew things have conspired to ruin the indexs batting average of late. So what happened? To be frank: theres too many ships.

"Theres massive overcapacity among large freight ships, and that overcapacity hides the true demand," says Jonathan Chappell, managing director in the research business at Evercore Inc. whos followed the index closely for years.

The financial crisis of 2008 came at the tail end of a five-year boom in shipbuilding, which was itself built on a seemingly endless demand from Asia for raw materials. Riding that wave, the worlds shipbuilders put their new found cash to good use, and built more ships.

The plan went smoothly untildemand for raw materials cooled, causing all these new tankersto line upfor their share ofa smaller and smaller pie of goods to ship. Excess supply caused freight prices to crater to levels they've yet to recover from.

"There was a time when shipping capacity was so tight that big swings in dry bulk rates made the Baltic Dry a great leading indicator," Chappell says. "But its not a great one now. Its either lagging or maybe irrelevant."

Since the recession, the index has been in as big a freefall as peoples faith in its predictive abilities. Down by more than 40 per cent in 2010 and 2011, some watchers are now sounding the alarm because the index has slipped from about 2100 to under 1000 in the past three months alone.

There was a time when a drop like that would have had traders heading for the hills. But as the chart above shows, the index was still well off its pre-recession peak to begin with and is, in fact, now closer to its historical norm.

One of the world's leading indicators is either waving the red flag of tough times to come, or suggesting things are just starting to get back to normal. So the canary in the coal mine might be at deaths door, but the miners, it seems, cant seem to agree on whether it was even a canary in the first place.