Recently there has been a lot of focus in the financial media about commodities prices with some commentators for example seemingly surprised how far the iron ore price has fallen. However on this site we have been warning that the days of high commodities prices were coming to an end, so the recent price falls have come as no surprise. In fact the Baltic Dry Index has been warning us what was likely to happen for a long time & also hinting what the stock prices for BHP & RIO were likely to do as well.
First let’s have a look at what has been happening to commodities prices and a good chart to use is the RBA Index of Commodities Prices.
As I warned a few years ago, commodities prices were set to fall. I wasn’t sure exactly when that would happen but as sure as night follows day, the commodities cycle would once again move into the over-supply phase.
At the moment record iron ore shipments have helped cushion the blow to the iron ore miners but when demand comes off the boil as I expect it will, prices are likely to fall even further. Many small mining operations will not survive and many higher cost mining operations will be mothballed as is already happening. That’s how the commodities cycle operates.
Regarding commodities, one indicator I have suggested investors watch over the years is the Baltic Dry Index (BDI). Many analysts and market commentators don’t pay much attention to this economic indicator which is why I suggest investors do.
Why? Because around 90% of world trade by volume moves by sea and the Baltic Dry Index reflects the prices paid to lease bulk carriers (ships). These vessels carry raw materials like iron ore and coal and if the owners of these vessels are doing it tough, then it’s worth understanding why.
Much of the pain in the bulk shipping sector has been self-inflicted i.e. too many ships were built during the boom years. But a similar situation has also been happening in the mining sector as investment poured into new mining projects over the last 5 years or so. This extra supply of commodities has pushed prices down and caused more pain for the bulk shipping sector which we can see reflected in the chart below.
Baltic Dry Index 5 Year Chart
Now many people will say that the Baltic Dry Index is no longer a reliable indicator which is curious since many of the same market commentators & analysts seem to think Chinese GDP data is reliable! I’d say the BDI is worth watching & that it is a reasonable leading indicator regarding where the commodities cycle is heading. However as with any market indicator, we just have to be remember not to bet the house (so to speak) on any one of them alone.
The chart of the Baltic Dry Index (BDI) shows 2010 & 2011 were generally happier times for the bulk shippers but still way below the euphoric (bubble days) prior to the GFC when the index was above 10,000!
Now let’s look at the charts of BHP Billiton (BHP) and Rio Tinto (RIO), two of the world biggest diversified mining companies and heavy users of ships that transport raw materials.
BHP Billiton 5 Year Stock Price Chart
Looking at the BDI chart we can see how the index moved past 4000 in 2009/2010 but by early 2011 it was coming back to earth and despite a few rallies since then, the BDI has struggled to hold above 1,000. (and at the moment is below the 900 level)
Now if we look at the 5 year stock price chart for BHP we can see how it started to pick up strongly in 2009 and then went on the hit a high around $50 in the first half of 2011 before falling back after that. So the BHP share price movement has basically lagged the BDI.
Just lucky perhaps? Well let’s check Rio Tinto.
Rio Tinto 5 Year Stock Price Chart
Once again with Rio Tinto we see the same sort of movement regarding its stock price as BHP and once again it lags the BDI. In other words it peaked after the BDI and started falling in earnest after the BDI.
Now I am not suggesting that this correlation between the Baltic Dry Index the share prices for BHP & Rio Tinto is rock solid. But what I am suggesting is that a correlation between them exists and that it is worth watching.
I will go further and suggest that the much maligned Baltic Dry Index is not an irrelevant economic indicator and that I would put more faith in it then the official China GDP numbers for example.
So what is the BDI suggesting at the moment? In simple terms that a major rally for shares for mining stocks like RIO and BHP is unlikely. But this doesn’t mean these stocks should be ignored and I will write more about this in my next post.
In the meantime I’ll say it once again – Keep your eye on the BDI!
This article was written by Greg Atkinson who is the Managing Director of Ohori Capital. Greg is from originally from Sydney but now works and resides in Japan. He can be followed on twitter via GregAtkinson_jp