Baltic Dry Index: Dark clouds on the horizon?

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Investors in mature-market equities, commodity prices, emerging markets and commodity-related currencies cheered the August PMIs released earlier this month as they came in better than expected, especially those of China. At the same time the Baltic Dry Index, seen as an important indicator of global trade, surged.

On the Investment Postcards blog in August I pointed out what was happening to the Baltic Dry Index and what the surge in that index implied. Thankfully, my analysis turned out to be not too far from what transpired. Yes, you may ask what prompted me to say that dark clouds may be on the horizon for the Baltic Dry Index.

Well, firstly, the Shanghai containerised freight indices for the major routes, Europe (Mediterranean) and North America, have plummeted over the past few weeks, taking the composite index to levels last seen in May this year.

Sources: chineseshipping.com; Plexus Asset Management.

Secondly, there is no follow-through on the jump in bulk ore freight rates apart from that experienced early in August. In previous blogs I warned about the impact of seasonal factors such as grain and coal imports on China’s manufacturing PMI. Over the past two weeks China’s coastal bulk freight rates for grain and coal surged by 6.3% and 10.2% respectively. When I look at the Baltic Dry Index and the freight rates of coal and grain I cannot help but think that there is a close relationship between them, obviously with leads and lags.

Sources: chineseshipping.com; Plexus Asset Management.

The question in my mind is whether the surge in the Baltic Dry Index was a forerunner of ship capacity ordered in anticipation of higher grain and oil imports. My gut feel says yes, especially in the light of the lack of follow-through on metal ore freight rates.

The strong rise in coal and grain freight rates is likely to improve China’s manufacturing PMI in September as inventories are increased, while orders are likely to improve as well. From a seasonal point of view September is also normally a strong month. China probably brought its orders for grain forward in the light of the worldwide shortage, while the hurricane season in the Mexican Gulf is intensifying.

But what is awaiting us, the market players? It seems to me significant weakness lies ahead, especially for the Baltic Dry Index. October is normally a weak month for China’s manufacturing PMI, the drop in containerised freight rates indicates that the global manufacturing sector is slowing, and both China’s manufacturing and non-manufacturing PMIs are sub-par compared to other normal years.

Sources: Li & Fung; I-Net; Plexus Asset Management.

Has the global financial markets overreacted on the somewhat better economic statistics? I think so. It seems to me that it could turn out to be just another “relief” rally.

I will hold on to my gold position and start hedging my equity portfolios.

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