There has been a recent flurry of agitated and panic laden emails and articles coming our way pressing the global trade collapse scenario and how we should all head for the hills with our tins of beans, automatic weapons and ammo.

The basis on which these dire warnings are being made is the dramatic drop in the Baltic Dry Index. The article that seems to have set this wave off is posted on one of the less reliable alternative news websites which gives us immediate cause for concern.

We agree that the free market capitalist system is in the process of collapsing from its current form into a new form. It seems to us that there are forces at work that wish to see a total collapse into financial, and ultimately social, anarchy while there are other forces that are seeking to establish a new world economic order modeled to their design. In the midst of such immense events it is important to remain sober and calm and not succumb to the agitation and panic that many commentators seem eager to generate.

So let's deal with the facts:-
- The Baltic Dry Index is a number issued daily by the London based Baltic Exchange. The index provides "an assessment of the price of moving the major raw materials by sea. Taking in 26 shipping routes measured on a timecharter and voyage basis, the index covers Handymax, Panamax, and Capesize dry bulk carriers carrying a range of commodities including coal, iron ore and grain."

- The Baltic Dry Index is a measure of the demand for shipping space in dry bulk carriers only, it does not include container shipping, oil shipping or anything else other than dry bulk goods.

- The Baltic Dry Index therefore measures the demand to move raw materials and precursors to production, as well as the supply of ships available to move this cargo.

- The Baltic Dry Index is not a "guide for the next 12 months of product delivery and food availability", unless you eat coal, iron ore, bauxite and raw grain.
The key determinants of the index are therefore Dry Bulk Goods Demand, Ship Supply and Ship Fuel (Bunker) Oil Prices. Seasonal factors will also influence the index as will the fact that about half global shipping has to pass through very narrow straits which put a cap on daily traffic. Similarly congestion in ports will also influence the index as will the general sentiment in the shipping market.

© InvestmentTools.comBaltic Dry Index
Before looking at these factors we should put the index into its proper historical context. Here is a graph of the Baltic Dry Index from 1st Jan 2000. The blue line is the index, the red the 20 day exponential average and the green line the 200 day exponential average.

The key points to note are:-
- The index's recent seemingly dramatic fall is from an exceedingly high peak.

- The current index levels are in the range that maintained from 2000 to 2003.

- The 200 day average (green line) filters out the "bumps in the road" and therefore provides a less dramatic and more sober picture.
So rather than have a panic at the return to what seem more like normal levels for the index we should seek to understand what drove it so high from 2004 to 2008. There are perfectly logical reasons why the index rose so high in this period.

© InvestmentTools.comCommodity Research Bureau Index from 1987
From 2003 the demand for coal, iron ore and other basic raw materials grew dramatically around the world and most particularly in China with its enormous industrial and real estate growth. This is illustrated by the rise (above average trend rates) in the Commodity Research Bureau Index (an index of raw material prices) from 2003 to its peak in late 2007:-

By the beginning of 2007 there was a severe world shortage of dry bulk ships such that Very Large Crude Carriers were being converted into dry bulk carriers in order to fetch ten times the charter rates. New orders soared in 2007 with shipyards not taking orders for new delivery until late 2009 such was the backlog. This shortage of shipping is regarded as being a major factor in the run up in shipping rates and therefore the Baltic Dry Index.

The US invasion of Iraq in March 2003 marked the beginning of the index run up and must be considered as a contributing factor due to a mix of market sentiment and the steady rise on crude oil, and therefore ship fuel (bunker) oil prices through to the end of 2008. This is illustrated in this graph which plots the BDI (in blue) against crude oil prices (in red) and shows a close correlation:-

So now we see China slowing down and the rest of the world contracting. The sharp drop in both commodity prices and in steel prices reflect this. Shipping capacity is both in less demand and also new capacity has come on line resulting in significant over capacity relative to both 2007 levels and current demand. The cost of ships fuel has also dropped significantly due to the drop in crude oil prices.

© InvestmentTools.comBaltic Dry Index & Crude Oil Spot Price
For the statistically minded there are numerous other graphs at InvestmentTools.com which further illustrate the Baltic Dry Index in its proper context.

So, rather than see the recent drop (and bounce) in the Baltic Dry Index as a precursor to doom it should be seen in its proper context as reflecting both the excesses of the previous 5 years and the natural contraction of global activity in this manufactured global financial crisis.

It is worth also remembering that the vast majority of the food we eat and the products we buy are shipped by container. Container shipping statistics are rather scant at present as European regulations caused the break up of shipping partnerships (conferences) in 2008 which were the previous source of data. However, the European Liner Affairs Association data for Asia to Europe traffic showed a 12% drop in volume Oct to Nov 08 which is much bigger than the usual fall between those months. The annual traffic volume is expected to have dropped roughly 13%. Europe to Asia trade dropped 16% Oct to Nov 08. Westbound Atlantic volumes dropped 15% while Eastbound dropped 12%.

The recent results from Singapore based Neptune Orient Line, which announced a $149 million loss for the fourth quarter of 2008 relative to a profit of $196 million for the same period in 2007, show the effects of this contraction.

This is much more reflective of reality; the world economy is contracting and global economic activity will shrink further but to bang the drums of doom and tell people to head for the hills with their weapons is pure scare-mongering and irresponsible.

That is not to say that the times ahead will not be very severe; they will be and there will be much suffering for us all. But to survive we need clear heads and sober analysis; we need cooperation and communication not isolationism and survivalist narcissism.