Source: Roy Luck via Flickr.
The Baltic Dry Index, or BDI Index, is held in high regard by some market watchers because it tends to be a leading economic indicator. This is because it is one of the first signals that global demand for dry commodity goods like coal, grain, or iron ore is changing as it measures the shipping rates for vessels that carry these goods. As such, it is said to be able to forecast economic changes on the horizon. If that's the case, it might be warning of troubles brewing at sea.
A false start?Earlier this year, the BDI Index hit a historic low, which would have signaled that the global economy was heading for disaster. However, this plunge had more to do with an increase in the supply of dry bulk tankers hitting the market than weak demand. As such, its ability to forecast what comes next needs to be taken in full context of not only supply and demand changes for dry commodities, but the change in the supply of the vessels transporting these dry goods.
That being said, the shipping industry seemed to quickly work out its overcapacity issues as the BDI Index roared back to life throughout the summer. In fact, the BDI Index more than doubled from its low of 509 in February to nearly 1,250 by August. However, since that August high the index has noticeably weakened. In fact, it has fallen to a recent level of just 876 in early September. With shipping rates falling for dry goods it suggests that the demand for these goods is starting to weaken as well.
Is a big storm on the horizon?The concern is that the drop in the BDI Index is signaling that a global economic slowdown is on the horizon. These are fears are being reinforced as economic data from places like China, which is a heavy commodity consumer, weakens.
For example, demand for Chinese goods in the global market has weakened over the past two months as its exports continue to fall. An 8.3% year-over-year drop in July exports was followed up with a 5.5% drop in August exports. Given how important exports are to China's economy this data suggests that its economy will slow even further because demand for Chinese goods has fallen. Therefore, it can be surmised that future demand for commodities by China will be weak, something that seems to already be playing out as its imports fell 13.8% year-over-year in August after slipping 8.1% in July. This is economic weakness appears to be confirmed in the drop in the BDI Index, albeit after the fact.
Therein lies the problem with the BDI Index as it isn't always predictive, but can also be reactive. For example, it was roaring higher earlier this year right when China was seeming to slow down. That's why its recent weakness might not be signaling a big economic storm, as it could simply be reflecting what has already happened.
Investor takeaway The BDI Index isn't a perfect predictor of future economic troubles. So, while it would seem to be indicating that global demand is falling, that could still be from the overhang of overbuilding ships that sent the index plunging earlier this year as new vessels entered service. That why it's best for long-term investors to really just avoid even paying attention to the BDI Index as it doesn't provide the clear crystal ball into the market's next move. It is better to simply buy good businesses than to try to gauge whether the BDI Index is predicting the future or not.
The article Is the BDI Index Signaling That Trouble Is Brewing at Sea? originally appeared on Fool.com.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.