There is an indicator which you can use which predicts the direction of the global economy, something fundamental to trading. It can predict when the economy is growing or contracting, give us a heads up in terms of if a recession is looming and also provides advance warning of price fluctuations in commodities which we can then use to interpret into currency trades. It’s used quite heavily by professional traders but very few retail traders are aware of it. It’s called the Baltic Dry Index (BDI).

What is the Baltic Dry Index I hear you cry, patience my friends, all will be revealed. The BDI is an index based on the costs of shipping raw materials across the globe. These are dry materials such as coal, iron ore, copper and cement, so this is distinct from oil shipping containers for example. Compiled by the Baltic Exchange they ask members to provide costs for shipping containers in different sizes across 22 different shipping routes. They take this information and produce the BDI.

Much like everything else in the world the cost of something is driven by supply and demand. So we can assume that if shipping costs are increasing so will the BDI, likewise dropping if costs go down. This change in price is again based on supply and demand, if there is high demand to ship raw materials across the globe then prices will go up and vice versa. Now the key thing is to remember that the BDI is looking at raw materials, and in particular, the demand for raw materials. This is very important.

If there is high demand for commodities then that suggests that global economies are growing, because they need these commodities to sustain the growth. The beauty with the BDI is it does this at a very early stage. Shipping charters will be ordered along way in advance so it gives you an idea of commodity demand in the future and therefore the overall performance of global growth. We know global growth is good for stock prices, commodity prices and some currencies particularly correlated with those commodities. The same works in reverse, if shipping charters are reduced that means there is oversupply of containers which means prices go down, hence it indicates slowing global growth.

Above is a real world example of the index from the Bloomberg Markets website. You can see how price is on the right hand side and how price fluctuates. In fact since October last year prices have dropped 40% which correlates with concerns around global growth that we have been talking about in the fundamental blog posts.

It’s that simple! It’s amazing indicator because it’s very hard to manipulate. The information comes from a large number of shipping providers who are not controlled by governments or speculators. It is driven purely by the laws of supply and demand. Remember it is extremely expensive to build a new ship not to mention it takes many years, to increase supply. It also costs far too much to have ships bobbing around empty in ports. Therefore those people who actually need the commodities are the people affecting the price.

In summary, the BDI measures the demand for shipping of raw commodities across the globe. If demand for shipping is high then it suggests global growth is healthy which should translate into increased stock prices, commodity prices and those currencies which are correlated with commodities. Likewise, if shipping costs are reducing it means there is less demand, therefore global growth is perhaps contracting leading to stocks and commodity prices falling and likewise the commodity currencies.

Andi

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