The sharp rise in the Baltic Dry Index does not signal an economic recovery.
Both the Shanghai Composite and the Baltic Dry Index (BDI) have been on the rampage of late. When the ‘decoupling’ bugle was heard the loudest, measuring the cost of space on dry-bulk ships and the price of shares in the Chinese domestic market attracted the most attention. According to the decoupling hypothesis; China would grow, irrespective of the recession in the US or Europe. Its incessant needs for machinery and raw materials would force it to import, and help the rest of the world survive recession. The rise of Shanghai saw ‘A’ shares rise 455 per cent in the two years to October 2007. In the following 12 months, the ‘A’ shares retraced ground by 72 per cent.
Right now, the S&P 500 Index continues to be weak but the Baltic Dry Index seems to be powering ahead, having risen 200 per cent from its low.
The winning streak of the BDI lasted 16 days in which the index rallied 1.3 times and was back below 2,000 on February 12. The Baltic Dry Index is up 200 per cent from its 22-year low of 663 back in December 2008.
But shipping has always been volatile. The Baltic Dry multiplied six-fold until peaking as recently as May 2008. Subsequently, in a dramatic turnaround, the BDI fell 94 per cent amid reports China had suspended imports due to the Beijing Olympics to ensure pollution-free games, and also on anecdotal evidence that the ships were leaving empty as a fallout of the global slowdown.
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While the Baltic Dry doesn’t have much correlation with US stocks, it is positively correlated with the Chinese equity market. Over the Baltic Dry’s 16-day winning streak, China’s Shanghai Composite index was up 14 per cent as well, and there are waves of hope that it is beginning to turn the corner.
If you examine the charts of the Baltic Dry Index and compare these with both the S&P 500 and China’s Shanghai Composite, you find that though the percentage changes are more extreme for the Baltic Dry Index, the direction of its movement is very similar to China and not so similar to the US. Given the fact that China is such an export-based economy, it’s no surprise that this trend exists.
It is important to note that Chinese imports in January dropped a whopping 43 per cent compared with a year earlier, by far the worst ever. Then, how could the Baltic Dry Index treble in the past two months? And how can Shanghai Composite Index have gained by a third in the same timespan?
On the positive side, while China’s Purchasing Managers’ Surveys point to a contraction, they have risen in each of the past two months. Banks too have money to lend and are actually lending, thus adding to the money supply in the system.
According to Goldman Sachs JBWere Pty Ltd analyst Paul Gray, Chinese imports of iron ore in January and February 2009 could be higher than expected. He notes Brazilian exports jumped 27 per cent in January, with China the likely recipient. Spot prices for Indian ore shipped to China are about 25 per cent higher than their October lows. Dry-bulk rates have picked up, as have ex-Australia freight bookings. Besides, Chinese domestic steel prices are on the rise at a time when northern Chinese ore supply has been constrained for seasonal reasons.
On the negative side, it is essential to note that the Baltic Dry Index declined more than 94 per cent from its peak-to-trough over the last two years. While it has made a nice move upward in the past few weeks, it is still very much down from its highs. Secondly, 16-day winning streaks are really not a big deal for the Baltic Dry Index. As shown in the graphic, the current winning streak is minuscule when looking at all winning streaks for the index since 1985. In fact, the record winning streak for the Baltic Dry was 48 up days in a row back in late 2004.
Jeremy Penn, chief executive of the Baltic Exchange, said the BDI’s recent firming resulted from a rush of orders for materials like iron ore and steel ahead of the week-long Chinese New Year holidays in the first week of February 2009.
I believe there will still be pain ahead for the shippers even though China’s iron ore stockpiles declined 22 per cent since September 2008. It looks like there could be vessel supply/dry bulk demand issues that could ruin the BDI party. So it could just be a temporary squeeze.
Lakshmi Mittal of ArcelorMittal has warned that underlying earnings at the world’s largest steel maker could slide by 80 per cent in the first quarter of 2009, indicating that the global demand for steel is still faltering.
Of the Chinese stimulus package announced some months ago, hardly a sixth to a third was new spending. Besides, part of the increase in bank lending consisted of putting loans back on the balance sheet — loans that had been taken off balance sheets in 2007 and 2008 when the People’s Bank of China was trying to constrain bank lending. It isn’t really new credit.
| BALTIC DRY INDEX | ||
| 16-day Winning Streak | ||
| Date | Baltic Dry Index | % Change |
| 20/1/09 | 872 | 0.46 |
| 21/1/09 | 900 | 3.21 |
| 22/1/09 | 945 | 5.00 |
| 23/1/09 | 980 | 3.70 |
| 26/1/09 | 995 | 1.53 |
| 27/1/09 | 1,004 | 0.90 |
| 28/1/09 | 1,014 | 1.00 |
| 29/1/09 | 1,036 | 2.17 |
| 30/1/09 | 1,070 | 3.28 |
| 2/2/2009 | 1,099 | 2.71 |
| 3/2/2009 | 1,148 | 4.46 |
| 4/2/2009 | 1,316 | 14.63 |
| 5/2/2009 | 1,498 | 13.83 |
| 6/2/2009 | 1,642 | 9.61 |
| 9/2/2009 | 1,815 | 10.54 |
| 10/2/2009 | 1,975 | 8.80 |
Not only that, corporate investment is hugely important to China’s economy, where capital spending accounts for more than 40 per cent of annual output. So, the profit decline will have major effects across the economy as companies have less money to buy new equipment or expand their businesses. Economists have long warned that Chinese companies’ heavy reliance on retained profits would tend to exaggerate swings in the nation’s investment cycle.
Yes, the Chinese stock markets rallied in January and February 2009 — but the Great Depression too had six rallies of over 20 per cent on the way to its bottom.
Both the Shanghai and the Baltic Dry Index are far below their highs and making judgements about the resurgence of the world economy based on 17 days of consistent rise of the Baltic Dry Index is premature. The recovery in the Baltic Dry Index (BDI) is more a technical correction from the extreme fall between October and December 2008, further aided by a pick up in Chinese demand for iron ore; it is not a sign of resurgence of world economic growth.
The author is CEO, Global Capital Advisors