Investors are always looking for practical economic indicators they can use to help them make informed investing decisions. Peter Lynch, the famous manager of the Fidelity Magellan Fund, talked about looking for practical indicators in the world around you—like looking at what products your friends are buying or what stores always seem to be crowded. The Baltic Dry Index (BDI) is a practical economic indicator on a global scale.

[VIDEO] Understanding the Baltic Dry Index

The Baltic Dry Index (BDI) is a measure of what it costs to ship raw materials—like iron ore, steel, cement, coal and so on—around the world. The Baltic Dry Index is compiled daily by The Baltic Exchange. To compile the index, members of the Baltic Exchange call dry bulk shippers around the world to see what their prices are for 22 different shipping routes around the globe. Once they have obtained these numbers, they compile them and find an average. To ensure they are getting a comprehensive view of the entire shipping industry when looking at various shipping costs, the Baltic Exchange looks at costs for each of the following four sizes of ships:

– Capemax (10 percent of the global fleet): ships that can carry 100,000+ dead weight tons of cargo and are too big to pass through the Panama Canal

– Panamax (19 percent of the global fleet): ships that can carry 60,000-80,000 dead weight tons of cargo and can barely fit through the Panama Canal

– Handymax, or Supramax (37 percent of the global fleet): ships that can carry 45,000-59,000 dead weight tons of cargo

– Handysize (34 percent of the global fleet): ships that can carry 15,000-35,000 dead weight tons of cargo

Why Investors Watch the Baltic Dry Index

The Baltic Dry Index is a leading indicator that provides a clear view into the global demand for commodities and raw materials. The fact that the Baltic Dry Index focuses on raw materials is important because demand for raw materials provides a glimpse into the future. Producers buy raw materials when they want to start building more finished goods and infrastructure—like automobiles, heavy machinery, roads, buildings and so on. Producers stop buying raw materials when they have excess inventory and when they stop infrastructure projects.

Typically, demand for commodities and raw goods increases when global economies are growing. For investors, knowing when the global economy is growing is helpful because that means stock prices, commodity prices and the value of commodity-based currencies should be increasing. Conversely, demand for commodities and raw goods decreases when global economies are stalling or contracting. For investors, knowing when the global economy is contracting is helpful because that means stock prices, commodity prices and the value of commodity-based currencies should be decreasing.

The Baltic Dry Index is also a compelling indicator because it is a simple, real-time indicator that is difficult to manipulate. Some economic indicators—like unemployment rates, inflation indexes and oil prices—can be difficult to interpret because they can be manipulated or influenced by governments, speculators and other key players. The Baltic Dry Index, on the other hand, is difficult to manipulate because it is driven by clear forces of supply and demand.

The supply that affects the Baltic Dry Index is the supply of ships available to move materials around the globe. It is difficult to manipulate or distort this supply because it takes years to build a new ship that could be put into service to increase supply, and it would cost far too much to leave ships empty in an attempt to decrease supply. The demand that affects the Baltic Dry Index is the demand of commodity buyers who need the raw goods for production. It is difficult to manipulate or distort demand because it is calculated solely by those who have placed orders to have raw goods shipped. Nobody is going to pay to book a Capemax cargo ship who isn’t actually going to use it.

Interpreting the Baltic Dry Index

The Baltic Dry Index typically increases in value as demand for commodities and raw goods increases and decreases in value as demand for commodities and raw goods decreases.

Here’s what it typically means when the Baltic Dry Index turns around and starts moving UP:

– Global economies are starting to, or continuing to, grow

– Companies are starting to, or continuing to, grow

– Stock prices should start to, or continue to, increase in value

– Commodity prices should start to, or continue to, increase in value

– The value of commodity currencies—like the Canadian dollar (CAD), the Australian dollar (AUD) and the New Zealand dollar (NZD)—should start to, or continue to, increase in value

Here’s what it typically means when the Baltic Dry Index turns around and starts moving DOWN:

– Global economies are starting to, or continuing to, contract

– Companies are starting to, or continuing to, contract

– Stock prices should start to, or continue to, decrease in value

– Commodity prices should start to, or continue to, decrease in value

– The value of commodity currencies—like the Canadian dollar (CAD), the Australian dollar (AUD) and the New Zealand dollar (NZD)—should start to, or continue to, decrease in value