When the fault lines rumble

There’s one tool that tells us when there is a seismic shift underfoot…

One index that lets you know something is wrong long before it reveals itself in the stock markets.

It’s better than any stock, or economic index – or, dare I say it, gold.

Why?

Because, at a glance, it gives information in real time.

Unlike inflation gauges, unemployment numbers, or even a company’s earnings report for the quarter – all of which are lagging data — this index depicts what is happening in real time.

It’s a here and now tally on how much things cost, how many things are moving around and how long it will take…

… where a commodities boom or bust will reveal itself…

… or the place where geopolitical stress will show up first.

Governments can’t put a spin on it and companies can’t massage the message.

It’s the manipulation-free index that can help you understand the market and better predict the market direction.

Oh, and it’s historically predicted market crashes too…

What’s a proxy for global economic health?

Meet the Baltic Dry Index or BDI as those in the know like to call it.

Dry bulk simply means commodities like iron ore, coal, grain, sugar and cement. They are all materials that are key inputs in the very basics of our way of life. These are things that are crucial to our food supply, energy and infrastructure. They are the absolute basics needed for the intermediate stage of production. 

The BDI is an old-school index. It’s not based on a futures contract or a bunch of maritime stocks. It’s a pure measure of maritime activity with the kind of maths you learnt at eight.

The folks over at the Baltic Exchange take samples everyday by calling people every day in major cities like London, New York, Tokyo, Shanghai, Beijing, Mumbai, Oslo, Athens, Geneva, Delhi and Genoa.

The ask questions about the cargo, the port of destination, the size of the ship, the length of the voyage plus the return trip. These questions are asked in relation to the 22 major shipping routes around the world.

What these calls reveal are a genuine representation of supply and demand.

As laborious as the process it is, it unearths how many ships are available for transport, what type of cargo appears to be in hot demand and if there are any bottlenecks at ports as shipping times have blown out.

You see the raw materials we use every day are rarely found where they are needed, or even close to where they will be processed and then shipped out in the final form.

What makes the BDI a leading indicator is because it measures activity at the one of the earlier places in the supply chain.

As you can see, it fluctuates and has volatile periods.

Baltic Dry Index

1985-present

Source: Trading Economics

What makes it unriggable?

The “demand and supply” drivers of the BDI are quite simple. If you understand those drivers, you will quickly see how the index cannot be rigged.

Demand comes from the manufacturer, who places the order for the cargo. Supply is the number of ships available to move them around.

When there are lots of ships available, the index tends to fall.

That’s in contrast to when there is a strong period of economic growth and lots of raw goods are in high demand. When this happens, it means there aren’t enough ships available to move the cargo: both shipping time and costs increase causing the BDI to go higher.

The BDI is considered near impossible to manipulate as it reflects real and current economic demand.

You can’t coerce thousands of manufactures to order stuff. They are only doing because their customers are demanding more. Plus, you can’t suddenly increase the number of ships available. Building massive cargo ships takes a minimum of two years.

In simple terms, the BDI shows the global economy expanding and contracting long before it appears in any government data or company share price.

Why is the (change in) trend your friend?

But the BDI comes with a bonus warning signal that stock price indices don’t have.

That is, it can tell you quickly when something is going wrong.

Have a look at the chart below.

The red line is the BDI and the green line represents geopolitical risk.

Baltic Dry Index has an inverse relationship with geopolitics

Source: Science Direct “Ocean & Coastal Management” December 2021
West Texas Intermediate oil price (OP) Baltic Dry Index (BDI) and geopolitical risk (GPR)

For the past 20 years, these two have had an inverse relationship. When there is something that is immediately disruptive or a threat to global trade, the BDI will suddenly turn down.

This extreme change of direction signals that something has gone wrong. Every major geopolitical event – like 9/11, the Iraq War, global recession and the escalation of the conflict between Russia and Ukraine in 2016 – has been an episode where the BDI sharply reversed its upward trend.

Here’s what really matters: the overall trend is useful to watch, but it’s the sharp change in direction that is the signal you need to look for.

A very sharp fall may suggest that a downturn is coming.

That means that the BDI can help you give the chance to reassess your risk tolerance before fears about geopolitical events reach the rest of the market.

Until next time,

Shae Russell
Co-editor, Exponential Investor