The Baltic Dry Index: The Only Economic Indicator Worth Tracking Right Now
by Louis Basenese, Advisory Panelist, Investment U
Associate Investment Director, The Oxford Club
Wednesday, November 12, 2008: Issue #884
Forget unemployment. Inflation. Consumer confidence. Personal Incomes...
You can even ignore the ever-popular gross domestic product (GDP).
Most of the indicators that the market relies on to forecast the future are worthless in this type of environment. The truth is the data coming out of the traditional economic indicators isn't current. By the time it's being reported, the information is already weeks or even months old.
If you want to know when the global slowdown that's erased $28 trillion in wealth (so far) will finally reverse course, pay attention to the obscure Baltic Dry Index. And nothing else. Here's why...
What Is The Baltic Dry Index?
Despite the name, the Baltic Dry Index has nothing to do with markets in Lithuania, Latvia or Estonia. Instead, it's all about the cost of shipping major raw materials. Like iron ore, coal, grain, cement, copper, sand and gravel, fertilizer, even plastic granules.
The value for the index is determined by the London-based Baltic Exchange, which traces its origins back to 1744. Each day, the exchange canvasses hundreds of brokers around the world for price quotes on moving goods. For instance: Shipping 100,000 tons of coal from South Africa to Japan, or 50,000 tons of iron ore from Australia to China. It then aggregates the quotes to form the Baltic Dry Index.
Basic economic principles of supply and demand explain the significance of the index...
The supply of cargo ships is tight and inelastic. It takes roughly two years to build a new cargo ship. And the high cost of each prohibits docking ships during slow periods. In other words, a change in cargo rates does not change the number of ships in operation. So even the slightest changes in demand for shipping raw materials results in a change in the index.
And because the index tracks the cost of shipping raw materials - the precursors of economic output - instead of intermediate or finished goods, it provides a precise and rare measurement of the volume of global trade at the earliest possible stage.
A sharp move up, means global trade is increasing. Conversely, a sharp move down, means it's decreasing. Since global economic activity ultimately influences the equity markets, sharp moves in the Baltic Dry Index often predict and precede similar moves in the equity markets.
4 Reasons to Favor The Baltic Dry Index
Of course, there are other reasons to favor the Baltic Dry Index over other leading indicators, including:
- No room for speculation. The index is not tradable, which means the only people booking cargo ships are those with actual cargo to ship. That makes the Baltic Dry Index, as economist Howard Simons put it, "totally devoid of speculative content."
- Not subject to revisions. Unlike almost every other piece of economic data, the Baltic Dry Index is not revised on a monthly or quarterly basis. The price is the price. And it's completely reliable.
- An inability to be manipulated. Governments, both here and abroad, love to "massage" economic data, especially inflation figures. Obviously, it's difficult to base investment decisions off incomplete or "mostly" accurate data. But because of the way the Baltic Dry Index is measured, that's simply not possible. Again, the price is the price. And it's completely reliable.
- Real-time, daily updates. We all know markets shift fast. And in turn, we need indicators able to reflect those sudden movements. At best, we only get weekly updates for other leading indicators. And all are backward looking. The Baltic Dry Index represents the only indicator with "real-time" updates. And such frequency dramatically increases its relevancy and value.
In light of the above, it doesn't take a market maven to predict what direction the index's been heading lately - practically straight down. Here's the thing. The Baltic Dry Index started plummeting in early June, before the global equity markets went into a tailspin, proving its predictive abilities.
So if you're looking for a clear indication of a market bottom, forget about any other leading indicator or popular convention. Just look for the Baltic Dry Index to start trending noticeably higher.
P.S. Here is a good resource to find out what the Baltic Dry Index is doing.
Today's Investment U Crib Sheet
Economic gauges used by Wall Street and economists alike are classified into leading, lagging and coincident indicators.
- Coincident indicators move at the same time and direction of the market. If you imagine a windsock moving with the wind, you can get a good idea of how they can confirm a direction.
- Lagging indicators trail the market. In our windsock example, imagine the sock moves well after the wind is already changing direction. While it doesn't help from a forecasting perspective, it does confirm larger trends.
- Leading indicators show us what direction the market is headed. Unlike the Baltic Dry Index, most leading indicators aren't a guarantee, so their data must be discounted. The data provided by most leading indicators don't inform us how long before the impact is felt. Imagine our windsock shifts direction before the wind changes, but we don't know whether the wind will change in a few minutes, or a few days.