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The Baltic Dry Index – Troubled Waters Ahead?

 

By Barry Downs             Printer Friendly Version
and Bill Matlack
August 4, 2005

AEGIS CAPITAL

Globalization has made economic forecasting ever more of a challenge because economists now need to know how developing economic conditions around the world will impact on various geographic locations, especially the world’s big centers of finance and commerce. The US has learned first hand that economic activity in China and India has impacted directly on America’s economy, as American jobs in alarming numbers are being outsourced to those far away locations.

Anyone following the American economy knows only too well the plethora of economic statistics pouring out of Washington every month. Wall Street is bombarded with statistics, which are constantly being revised and represent tracks of economic activity recently left. The important job today, however, is to determine what the economy will be doing in the future and on a global scale, in order to make investment decisions which will be appropriate for next month and next year. Measuring the direction of the global economy in a new globalized world is then critical to investment decisions and perhaps more obscure indicators have greater relevance in today’s world than the assortment of skewed government indicators and statistics presently disseminated!

One obscure indicator that is proving its suitability for a globalized world is the Baltic Dry Index (BDI).

The BDI is issued every business day by the London-based Baltic Exchange. The Baltic Exchange had its early roots in the Virginia and Baltic Coffee House in London’s financial district in 1744. Every business day Baltic executives canvass shipping brokers worldwide and ask the rate to book various cargoes of raw materials on various shipping routes around the world. Variables are considered such as type and speed of the ship and length of the voyage. Answers are then molded into the BDI.

The BDI provides an assessment of the price to move the world’s major raw materials by sea and insight into the global shipping market.  It is an accurate barometer of the volume of global trade. A large demand for shipping means rising rates, and slack demand means lower rates. The BDI doesn’t deal with ships carrying finished goods. It only deals with precursors to production, so the index seems to be a better indicator for economic growth and production and is devoid of speculative content. No one books an ocean freighter on a hunch! When bulk shipments of cement, grain, iron ore, etc. are arranged with a shipping company, there is economic activity planned at the end of the line where the raw materials are delivered.

In examining the ocean-going shipping business, it is found that the supply of cargo ships is both tight and inelastic. It takes two years to build a new ship and ships can’t be mothballed. Marginal increases in demand for shipping pushes the index higher quickly, while significant increases in demand can push the index sharply higher. Marginal and significant declines in demand have the opposite impact on the index.

Movements in the BDI, as a leading indicator, have tended to precede movements in global stock markets.  The index also tends to presage higher interest rates, because when larger volumes of raw materials are being shipped around the world, there is a greater need for financing and interest rates tend to rise.

This takes us to the direction of the BDI and the 10-year, 5-year, and 6-month charts, as reflected below.




The index registered a blow-off high near year-end 2004 at the 6250 level and plunged. An attempted rally in the first quarter of 2005 failed and since mid-April the BDI has dropped 63%.  Over a 52-week period, the index has plunged 72%.

We already know that the European economy has slowed down appreciably. Britain alone has just reported the slowest economic growth in 12 years and the German economy is terribly anemic. Also, in Asia the Chinese economy has become overheated, and there is concern for the banking industry and possible negative impact on the Chinese economy.

The BDI chart seems to be predicting a significant slowdown in global economic activity which, for the world’s stock markets, would mean the end of the cyclical bull market and a return of the secular bear market, and probably with a vengeance. For the world’s capital markets, the dropping BDI should, in theory, mean lower interest rates. But in the debt-ridden US, a declining economy will cause an unprecedented real estate implosion for starters, which logically would cause interest rates to rise as defaults soared and the mood of Americans changed from fearless to fearful.

For the world’s gold devotees, fear has been the missing ingredient, which has kept the precious metal in the doldrums while real estate has been in the limelight. If fear gets a grip on world markets, gold will suddenly become the preferred chaos hedge.

Unless the BDI has suddenly become skewed by something which is not apparent, like an undocumented large supply of new bulk shipping tonnage, the collapse of the index since April is predicting a drop in global economic activity and trouble ahead for investors.

Something appears to be amiss globally, and it could become dangerous to one’s financial health to ignore the BDI’s precipitous decline.  Troubled waters may be ahead!

Research Comment Precious Metals

Barry Downs** (775) 852-3875

bdowns@aegiscap.com

Bill Matlack** (201) 217-5680

bmatlack@aegiscap.com

*****

**Barry Downs and Bill Matlack are stockbrokers specializing in gold and mining equities with Aegis Capital Corporation, a registered broker/dealer, in New York, New York.

Company Risk Disclosure In addition to the risks involved in investing in commodities generally, we also highlight the following risks that pertain to this commodity. Gold is highly levered to the relative strength of the U.S. dollar, the U.S. balance of trade, and inflation generally, as well as to political and economic stability worldwide.

Analyst’s Certification We, Barry Downs and William Matlack, hereby certify that the views expressed in this report accurately reflect our personal views about the subject commodity. We also certify that we have not, are not, and will not receive, directly or indirectly, compensation for expressing the specific recommendations or views in this report.

General Disclosure The research analysts (or their household members) who prepared this research beneficially own gold securities and physical gold. Aegis Capital Corporation (“Aegis”) or an affiliate expects to receive and intends to seek compensation for investment banking services from gold equity issuers within the next 3 months. The analysts who prepared this research report may be compensated based upon (among other factors) investment banking services.

The opinions, estimates and projections contained herein are those of Aegis as of the date hereof and are subject to change without notice. Aegis makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. However, Aegis makes no representation or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions which may be contained herein and accepts no liability whatsoever for any loss arising from any use of or reliance on this report or its contents. Information may be available to Aegis or its affiliates, which is not reflected herein. This report is not to be construed as an offer to sell, or solicitation for, or an offer to buy, any securities. Aegis, its affiliates and/or their respective officers, directors or employees may from time to time acquire, hold or sell securities mentioned herein as principal or agent. Aegis may act as financial advisor and/or underwriter for certain of the corporations mentioned herein and may receive remuneration for same. TO U.K. RESIDENTS: The contents hereof are intended solely for the use of, and may only be issued or passed onto, persons described in Part VI of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001.