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Commodities Prices, the Baltic Dry Index, BHP Billiton & Rio Tinto

June 17th, 2014 · Greg Atkinson · 12 Comments

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.

rba_index_commodities_prices_may_2014

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

baltic_dry_index_5_year_chart_june_2014

Source: Bloomberg.com

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.Β  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

bhp_5_year_chart_june_2014

 

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

rio_tinto_5_year_chart_june_2014

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


12 responses so far ↓

  • 1 Ross T // Jun 19, 2014 at 10:06 pm

    Time to get back in the market Greg – now TA is back from O/S and pup is in the senate the deregulation/ investment will begin — the share boom is already underway in anticipation. There is plenty of cash out there looking for a return. Nickel and oil/gas look good – Iron ore very soon.

  • 2 Greg Atkinson // Jun 20, 2014 at 11:49 am

    I’m not very bullish on iron ore but maybe the price is starting to find a bottom. Then again if the Chinese property bubble were to pop then I reckon iron prices would drop further and take mining stocks like RIO & BHP down as well.)

  • 3 Lachlan Scanlan // Jun 21, 2014 at 8:26 am

    Clive is educating the right wing lol…spend spend spend.

  • 4 Greg Atkinson // Jun 21, 2014 at 9:29 am

    Things could get very interesting as this extract from an article in the Nikkei Asian Review suggests:

    “At the same time that China is ramping up steel production, major metals and mining companies such as Rio Tinto and BHP Billiton are planning to boost production of iron ore and coking coal. With supply outstripping demand, the price of iron ore in May fell below $100 per ton, a break-even point for small and midsize producers, and the price of coking coal dropped to $107 per ton in March, marking the lowest level in about five years. Falling raw material costs are one reason steel producers are reluctant to reduce output. As Chinese manufacturers are squeezed by declining steel prices, they demand lower prices for raw materials and put off purchases as long as possible.

    The long term effects could be dire. “If the price of iron ore continues as it is now, mining in China, with its low productivity, will go out of business,” said Jiro Iokibe, a senior analyst at Daiwa Securities. The development of a natural resources oligopoly might eventually send prices higher again, but the impact on the real economy as weaker companies are weeded out “would not be small,” Iokibe said.”

    Source: Oversupply in China drags down Asia’s steel market. Nikkei Asian Review – 19th June 2014.

  • 5 Lachlan Scanlan // Jun 23, 2014 at 9:07 am

    While the DowGold ratio is still on the up and not really over bought even the AUD gold price looks like a fair chance of a technical breakdown to a lower low at present. Could there be a chance of XJO strength towards 6000 and a gold sell off…there is a correlation there sometimes Greg…as you said once. Still a gold bull for the long term btw πŸ™‚
    Of course if such a thing happened I’d be hoping for a proper new rally in gold after a stocks pause/pullback.

  • 6 Greg Atkinson // Jul 1, 2014 at 2:56 am

    Looks like the XJO might be setting itself up for a fall rather than a rally at this stage. I am also getting more bearish regarding commodities at least for the short term and if commodties prices do fall further, I reckon this may drag the ASX 200 down below 5200.

  • 7 Lachlan Scanlan // Jul 5, 2014 at 5:46 am

    Interesting finish to the upside there Greg but that was at odds with a weak and diverging RSI.

  • 8 Greg Atkinson // Jul 9, 2014 at 12:16 pm

    I wonder with the benefit of hindsight if we will look back and say the market peaked this year at around 5500? That’s what I am thinking now, so stand-by for the rally up to 6000 πŸ˜‰

  • 9 Lachlan // Jul 13, 2014 at 7:37 am

    that’s the way Greg, go 6000! go!…wanna win my bet with the fellas this year. I see gold has been strong lately but if there is going to be a new “gold weakness/shares strength” event then we could be close to the start even now, could be. I could be wrong too of course πŸ™‚ …lets get our epistemology right here…we’re all clueless lol

  • 10 Biker // Jul 14, 2014 at 3:57 am

    Lachlan: “…we’re all clueless lol…”

    But, it’s unlikely that with “…benefit of hindsight if we will look back…” on prophecies which were LOL-able, made here years ago.

    Just isn’t PC!~ πŸ˜€

    Biker, Vancouver

  • 11 Stillgotshoeson // Aug 20, 2014 at 11:38 pm

    A big jump in the BDI Greg…

    http://www.kitco.com/news/2014-08-20/Soaring-Shipping-Measure-Signals-Improving-Health-of-Global-Economy.html

  • 12 Greg Atkinson // Aug 25, 2014 at 11:32 am

    Well with the BDI recently we need to keep “soaring” in perspective as it usually means a jump from a very low level followed by a drift back down again. As it stands today it looks like the drift back to below 1000 is already in play.

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