A More Accurate Commodity Price Indicator

A Financial Times blog post suggests the Baltic Dry Index is "a rubbish indicator” of commodity prices – a harsh but somewhat accurate description of an index that’s not designed for that purpose.

At most, the BDI is only an indirect indicator of commodity prices – it measures costs to charter ships that carry bulk commodities such as grain, ore and coal. Ship-chartering costs reflect cargo demand but as some FT blog commenters note, they also reflect vessel supply.

Supply of bulk carriers has been rising faster than demand. Bulk ships on order total about 60 percent of the existing fleet, and London shipbroker Clarksons reports more than 167 bulkers with capacities of 14.4 million deadweight tons were ordered from shipyards during the last two months.

Excess vessel supply is the main reason the Baltic Dry Index declined Thursday for its 30th straight day, falling to 1,940, down from 4,187 on May 25. The BDI has been volatile. A red-hot charter market, fueled by Chinese demand for commodities and a shortage of ships to carry them, drove the BDI to a peak of 11,793 in May 2008 before the recession caused it to plunge to 663 last December.

Even the most speculative commodities usually don’t fluctuate as much as the BDI, a useful index for ship charters but only an indirect indicator of commodity prices.

A direct indicator is The Journal of Commerce-Economical Cycle Research Institute Industrial Price Index. The IPI measures prices of 18 industrial materials such as aluminum, plywood, burlap, crude oil and even tallow, which is used in production of soaps, detergents and chemicals.

Prices for these commodities, some of which aren’t publicly traded, are closely linked to cycles in global industrial growth, which helps drive the demand side of the Baltic Dry Index.

In recent weeks, the JOC-ECRI IPI has been trending down, suggesting a slowing of the economy (see JOC's June 7 cover story, Economic Recovery: Built to Last?). The IPI declined for six straight weeks before edging up for two weeks in mid-June and dipping 0.9298 to 112.70404 for the week ending July 2.

The decline was signaled last year by ECRI’s Long Leading Index of Industrial Growth, which provides an even earlier indication of economic trends. The LLIIG turned downward in January 2009, a year before IPI growth topped out.

--Contact Joseph Bonney at jbonney@joc.com.

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