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Inside the World's Coolest-Named Index, the Baltic Dry Index

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Despite having a very cool name, the Baltic Dry Index is down 58% from its peak in May, and down more than 80% from it's all-time high in 2008. Ok, so what is it, and should we be concerned?

First, what it is. The Baltic Dry Index is a number issued daily by the Baltic Exchange, a London-based organization whose members arrange for ocean transport of industrial bulk commodities from producers to end users. What kind of industrial bulk commodities? You know, the usual stuff: iron, ore, coal, syobeans.

Right. It's a number issued? What do you mean by "issued"?
Well, every day they survey brokers around the world to find out how much it costs to book cargoes of these raw materials on a variety of shipping routes. The answers are then reformulated as the Baltic Dry Index. The number of the index, 1761 as of yesterday, is a composite average of four different sizes of dry bulk shipping vessels, Capesize, Panamax, Supramax and Handysize.

This is a panamax vessel, which comprises about a fifth of the world's fleet of dry bulk shipping vessels.

Great. How do I play it? Alright, calm down, tradey trader. The Baltic Dry Index isn't a speculative index... at least not yet. That means no one is out in the market bidding if up or selling it, at least not directly. Instead, it tracks the actual cost of shipping raw materials by sea based on real cargo bookings and is therefore considered a pretty good indicator of global trade volumes.

Why? Well, that leads us to one reason people are giving for the collapse in this index - the supply of cargo ships.

It takes two years to build ships. And if you look at the chart below, you'll see that two years ago the index was.... that's right, at an all-time high. And what do ship builders do when demand for raw materials and the cost of shipping these raw materials are at all-time highs? They build more ships. Willaim Lyth, from the Baltic Exchange says that right now there are too many ships. "People have over-ordered and it is starting to bite. There are 235 new Capesize vessels hitting the market this year,” he told The Telegraph.

Because the index measures demand for shipping capacity versus the supply of ships, you have the double whammy of too many ships and too little demand for raw materials. Over the past 30 years, the historical monthly average closing price of the Baltic Dry Index has been 2133. We're below that now, the impact of the dual deflationary forces of too much ship supply and a dampened demand for raw materials, which is a consequence of the deflationary debt unwind we're experiencing.

Is the index a leading indicator of economic activity? That's what the economists say. After all, we're talking about massive vessels that ship raw materials - what the economists call "inputs" into the production of intermediate and finished goods -- and therefore, in theory at least, provides a window into future economic activity. But what about financial markets? Is it predictive of the stock market? Wouldn't the fact that this index predicts economic growth in turn possibly predict the direction of the stock market? Are stock values not simply market predictions of future cash flows and, ultimately, profitability of businesses? Hahaha. That's a good one. Here's a 10-year chart overlaying the Baltic Dry Index and the S&P 500.

POSITION:  No positions in stocks mentioned.