The BDI Is No Longer A Good Indicator Of World Economic Conditions

Implications: Several studies has noted the strong correlation between the Baltic Dry Index and world economic health.  Since much of the cargo carried on dry bulk ships is the precursors to manufacturing, the strong relationship makes sense.  For many reasons, the current BDI no longer follows this historical trend.

Analysis: Historically, dry bulk freight rates follow demand growth, which correlates nicely with world economic conditions.  Occasionally, extremes on the supply side have a disproportionate impact on rates, and skew the rates.

In most maritime segments, fleet utilization between the 86% to 93% levels exhibit a very linear function with rate levels.  In other words, incremental increases or decreases in utilization result in a rather fixed response in rates.  Above or below those utilization levels, we tend to see more of a geometric response in rates.

For the last two years, we have seen virtually 100% utilization in the dry bulk fleet.  At such high levels, minor disruptions in either supply or demand will result in large swings in freight rates.  In 4Q07, continued congestion in Australia, poor Australian wheat harvest, and iron ore contractual commitments combined to drive rates up to record levels.  Unfortunately, those levels were unsustainable based on the market fundamentals, and a correction was in order.  At the same time, disruption in iron ore supply from Brazil has left some 50+ ships temporarily without cargo.  Thus, we have had a massive fall in rates that no one expects to persist for very long.

The conclusion is that while the BDI is a good indicator of world economic conditions in the long term, during periods of abnormally high or low utilization, the index cannot be trusted as it becomes disconnected from underlying demand movements.