Should you make investment calls based on the Baltic index?

The Baltic Dry Index has slumped by more than 50% from its May high, sparking concerns that demand for commodities is falling.

The 28 days of consecutive falls in the index , which tracks worldwide international shipping prices of dry bulk, is its worst run since 2005.

But economists say that investors should be wary of making any big call on commodities on the back of this.

‘For a start, fluctuations in the index could be driven by changes in the supply of shipping as well as in the underlying demand for commodities transported by seas,’ says Julian Jessop, chief international economist at Capital Economics. ‘For example, a fall in the BDI could reflect an increase in the number of ships available to carry dry commodities, either new-builds or conversions from other uses, such as oil tankers.’

‘Similarly, the BDI might be distorted by temporary port closures, changes in the cost of fuel and insurance and many other factors.’

Although it cannot be described as unexpected, it is known that at the height of the boom there was a surge in orders for new cargo ships and given that they take two to three years to build, many of these are starting to come on stream now.

‘It is therefore at least conceivable that the BDI could fall further this year even if commodity prices rebound, provided the corresponding increase in demand for shipping is more than offset by an increase in supply,’ Jessop says.

Leaving the issue of shipping supply to one side, the BDI’s track record as a leading indicator is not overly impressive, according to Jessop, who says that at best it reflects current prices rather than being predictive.

‘Given that most commodities now have well-developed futures markets, the BDI is not much use as an additional forecasting tool,’ he says. ‘Indeed, it has often sent misleading signals, particularly for industrial metals such as copper.’

‘The correlation with agricultural commodities has been more reliable, reflecting their greater importance in the dry bulk shipping market, but again the BDI is no more than a coincident indicator.’

The upshot therefore is that the index serves as an indicator of prevailing market conditions, albeit with the added risk of being distorted at times.

As an aside, Jessop expects copper prices to fall from their current level of just over $6,000 per metric tonne to around $5,000 on the back of a slowdown in the global economy and Chinese demand in particular.

‘That call has been consistent with the recent weakness of the BDI but is certainly not dependent on it,’ he adds.