Why is The Baltic Dry Index Falling

The Baltic Dry Index has fallen 42.5% to 2468 (as on 21st August 2009) from a 2009 high of 4291 reached during 3rd of June 2009. This article looks into the possible reason for this dramatic fall in the Baltic Dry Index which has raised questions about the demand for industrial commodities and hence the recovery of China and other major commodity importers. The article will also try to access the impact of the fall in the Baltic Dry Index on key commodity prices.

Since, the Baltic Dry Index is known to have a close corelation with the Stock Markets, analyzing the index might also give a clue as to where the markets are headed. However, I must mention that of late the index has gone down but the Asian stock markets have done relatively well. So one should not only look at the BDI for judging the trend of the markets.

One Year Baltic Dry Index Chart: (Chart Source:Bloomberg)


As it is clear from the chart above, the BDI has been on a declining trend since June.

Why is the Baltic Dry Index Falling

Reason -1
Iron Ore Stockpiles have surged to the highest in 10 months in China

The chart below gives the Iron ore inventory stock currently at the various ports in China.


So the inventory of iron ore, which is used for steel making is already very high in China. This has been due to the record import of iron ore during the first half of 2009 by China. However, China will not be importing iron ore at the same pace in the second half of the year. This is primarily due to the following reasons:

• The government has discouraged stockpiling of commodities.

• Higher prices of Iron Ore will give incentive to Chinese miners to restart their production which will also generate some local employment. This again would reduce the demand for imports.
  

How much Iron Ore has China been importing

To get an idea of how much of excess inventory is built up in China, I would like to present another chart which gives the quantity of iron ore imported by China in the last five years.

Quantity of Iron Ore Imports by China (Chart Source: Bloomberg)


What this chart shows is that the import of Iron Ore by China during the last few months was much higher then the iron ore imported by it even during the peak of its economic activity. From this one can imagine the huge inventory build up which might have taken place over the last 6-9 months.

What this also tells us is that a decline in the BDI does not necessarily mean that industrial or infrastructure buliding activity has slowed down in China. This might be one of the reasons that the stock market has not declined even when the BDI has fallen drastically.

Reason -2
China Shuns Coal Imports, Opens mines

It was reported on Bloomberg on 24th August 2009 that China is opening mines idled by worker deaths this year following safety upgrades in a bid to bolster economic growth. It is expected that China’s largest coal- mining province, Shanxi, will boost output by 60 percent in the second half of the year. This would mean an increase of 150 million metric tons, almost twice what Germany burns annually.

After importing 48 million tons of Coal in the first six months of 2009, China’s July coal imports fell 13 percent to 13.9 million tons from 16 million tons in June.

This decline in import of coal would adversly impact the BDI and also lead to a decline in the coal prices in the near term.

However, China would not mind this as a decline in prices would again give China the incentive of importing coal at a cheaper rate and also get rid of its excess Dollar reserve by buying up more commodities.

Reason- 3
China's Copper Imports dropped for the first time in the last six months

China's import of copper in July dropped by 15% as compared to June to 406,612 metric tons. This was the first decline in imports in the last six months.

Bloomberg Reported that:
"Importing copper began incurring losses from late May, as overseas prices climbed faster than those in China, Pang said, adding record shipments in June were orders made earlier in the year. Inbound shipments result in losses of about 800 yuan a ton, after a 17 percent value-added tax, according to Bloomberg calculations. "

Thus, higher copper prices coupled with huge stockpiles of copper in China has lead to this decline in demand in the near term.

Why Stock Markets are not falling in line with the Baltic Dry Index

• The last time the BDI slumped (October 2008- March 2009), the fall was associated with a free fall of the global economy, a credit freeze and a strong decline in industrial activity. Thus, the stock markets also crashed in line with these major negative cues.

• Currently, the BDI has slumped due to decline in imports from China. However, this does not also signal a overall slump in their economy (at least for now) or the global economy.The decline in imports for China is supposed to be compensated by an increase in internal production. This should be good for the economy in the near term in terms of job creation. Thus, the fall in the BDI is not a major reason for panic for investors unless it becomes more sustained and reflects a real drop in demand again.
  

Conclusion:

• The government data clearly shows that China has slowed down on its aggressive stocking of all key commodities.

• The decline in imports due to local mine opening, high inventory and price negotiations with industrial commodity producers has adversly impacted the shipments to China and hence the Baltic Dry Index.

• Thus, the decline in the BDI does not show that global economic activity is again slowing down.

• The decline in import of key commodities is expected to adversly impact the price of all commodities in the near term. Thus, industrial commodities should see some meaningful price correction.

• As prices correct, China would again up its imports. This would be a broader strategy of China to buy commodities on dips and also get rid of some of its excess Dollar reserves.

A key thing to watch out for will be:

"Credit tightening in China (if it happens now) and its impact on Commodities."