A Little-Known Market Indicator Screams “Panic”

A Little-Known Market Indicator Screams “Panic”

The Baltic Dry Index is crashing and that should be cause for alarm. But few traders flow this index, so the crash is largely being ignored outside the shipping industry.

An Important Index for Global Investors

Even if you only invest in the U. S. stock market, you have exposure to global markets. Many large firms report a significant amount of sales in foreign markets. Many even obtain financing in those markets and carry debt in various currencies.

Smaller companies might not have international sales but may rely on international supply chains. This is almost inevitable in some industries, even if the company only does business with U. S.-based distributors.

Since all investors face risks associated with global economic trends, the Baltic Dry Index could be useful to follow.

This index is maintained by the Baltic Exchange, which is the world’s only independent source of maritime market information for the trading and settlement of physical and derivative shipping contracts.

The exchange has more than 600 member firms that encompass the majority of world shipping interests. Baltic Exchange members are responsible for a large proportion of all dry cargo and tanker fixtures as well as the sale and purchase of merchant vessels. [1]

Members report pricing information and the Exchange calculates pricing indexes which are useful for spotting trends in the shipping industry. In general, rising indexes show an increase in demand and that is consistent with a growing economy. When the index falls, supply of ships exceeds demand for shipping.

Specifically, the exchange uses the following formula [2] is used to calculate the Baltic Dry Index:

((Capesize 5TCavg x 0.4) + (Panamax 5TCavg x 0.3) + (Supramax 10TCavg x 0.3)) x 0.10

TCavg = Time charter average

Capesize, Panamax, and Supramax refer to different size ships as shown in the figure below.

shipping freights

Source: Shipping and Freight Resource [3]

These are the largest ships in the world. The Index tracks only dry cargo so ignores the rates charged on oil tankers or other types of cargo. That makes the Baltic Dry Index a leading indicator of global economic activity.

Its level is a measure of the supply and demand to move products around the world. The demand is based on consumers. The supply factor in the index is the number of ships of that size that are available. Supply factors tend to change slowly and short-term moves in the Index are related to demand.

A Crash Coincides with the Appearance of the Coronavirus

In recent weeks, the Baltic Dry Index crashed, dropping 82% in the past five months.

Baltic Dry index

Source: Optuma [4]

The index is now at its lowest level since late-2016. This could signal that disruptions for large multinational companies are likely.

There are no speculators in the market for shipping and the Baltic Dry index is a pure measure of demand for shipping at this point. New regulations required a switchover to a more environmentally friendly fuel type this year. That pushed some ships out of service and leaves a relatively stable fleet in place for now.

Economic growth was slowing in 2020. That’s confirmed by the September peak in the Index. News like a pandemic coming at a time when a slowdown was likely could make the downturn in manufacturing even worse.

Risks are now high in the global economy and the decline in the Baltic Dry Index shows risks to financial markets are rising.

Regards,

Michael Carr, CMT, CFTe

Editor, Peak Velocity Trader

Sources:

[1]: Baltic Exchange — https://www.balticexchange.com/about-us/

[2]: Baltic Exchange — https://www.balticexchange.com/market-information/indices/BDI/

[3]: ShippingandResource.com — https://shippingandfreightresource.com/baltic-dry-index/

[4]: Optuma — https://www.optuma.com/research/

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