Commodity prices: what does the Baltic Dry Index tell us?

Many financial analysts view the currentslide in the ‘Baltic Dry Index’ as indicative of an upcoming collapse incommodity prices, however we do not believe the story is quite that clear cut.

The Baltic Dry Index is a composite indexwhich tracks the cost of shipping iron, coal, and wheat based on the appraisalof a panel of professionals.

As the supply of ships and port machinerytakes a long time to respond to any changes in price, sudden shifts in theindex are assumed to be the result of a change in demand for dry commodities(wood, copper, iron, coal, and wheat).

This index is an important indicator for New Zealand as it gives us an idea of world economic activity.  Often analysts infer that asignificant increase in the index suggests an increase in world investment andconstruction.

Between November and January, the BalticDry Index slipped 48%, as rates for shipping have fallen (see Graph 7.1).  Therewas some recovery in February, but the index still remains well off its peak inNovember.

Graph 7.1

There are two different stories for therecent movement in the Baltic dry index: the pessimistic story and theoptimistic story.

The pessimistic story

The pessimistic story puts the index’sfall solely down to a reduction in demand for dry commodities.  If the dip isthe result of a fall in demand for dry commodities, and nothing else, then itspells potential problems for New Zealand for two reasons.  Firstly, a slide indemand for dry commodities would depress already low log and timber prices. More importantly, a fall in demand for these commodities may imply a slowing inworld economic growth, putting downward pressure on prices for our softcommodity exports (ie meat and dairy products).

However, this story is inconsistent withthe actual movements in commodity spot prices.  The price of many drycommodities fell very slightly (if at all) over December and January (see Graph7.2), indicating that underlying demand for these commodities was still strongwhen the Baltic Dry Index declined.

Graph 7.2

The optimistic story

Another popular story states that theBaltic Dry Index has eased as the result of negotiations between ore suppliersand transport companies.  In this case, a temporary reduction in ore hasreduced the demand for transport from the suppliers, and once these negotiationsare over the index will move back to its previous highs.

If this is the case, New Zealand has nothing to worry about, because world economic growth remains strong, and the costof shipping our logs and timber overseas is temporarily lower – an added bonus.

Yet if this is the case, why didn’t theprice of dry commodities shoot upwards?  If the volume of ore supplied to themarket has fallen then, all other things being equal, the spot price of oreshould increase.

Conclusion

As a result, it seems that we areexperiencing a mix of both stories.  Overall demand for dry commodities iseasing, and suppliers are limiting volumes.  Together these factors have drivena significant reduction in the Baltic Dry Index.

Overall, this is a negative story for New Zealand, but not to the degree that some analysts are portraying.  The significant dipin the index does indicate that demand for commodities are beginning to ease,but the current constraint on the supply of some goods suggests that the slipin the index overstates the weakness in commodities.


Economic Outlook · Transport Activity and Prices · The Car Market · Residual Values · Sectors · Commercial Vehicles · Commodity prices: what does the Baltic Dry Index tell us · Sea Change – what does it mean for transport?

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