Is the Baltic Dry Index on the Rebound?

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What was once a prestigious leading macroeconomic indicator, the Baltic Dry Index (BDI), has seen its relevance questioned by major outlets such as the Wall Street Journal.  At the WSJ, contributors have been debating whether or not this index is still a leading indicator (or a lagging indicator), and whether or not overproduction of large ships during 2008 has created a scenario in which the shipping industry cannot book to capacity.

Regardless, the BDI does do one thing better than any other index: it measures the cost of shipping raw materials such as iron ore and concrete, around the world.  Second, an analyst at The Street makes a great point by noting that the BDI is devoid of speculation because, "people don't book freighters unless they have cargo to move."  Finally, after viewing the U.S. Navy's "100%" commercial where the Navy maintains that 90% of global trade travels by water, I personally believe that the BDI deserves to be monitored by investors seeking market-beating returns.  Currently, the BDI is up 24.33% from January's free-fall:

<img src="/media/images/user_681/baltic-dry_large.PNG" />

If this rebound continues there are several stocks worthy of buy-and-hold investors' consideration.  The following commentary will highlight three approaches to consider with respect to the BDI: the front-door approach, the back-door approach, and the intangible approach.

The Front-Door Approach

The most obvious, albeit risky, method for capitalizing on an increase in the BDI is to simply invest in companies that rent ships at market prices instead of pre-negotiated rates.  Firms such as Baltic Trading Ltd. (NYSE: BALT), and Eagle Bulk Shipping (NASDAQ: EGLE) have models that incorporate spot prices.  Because the BDI is near the Great Recession lows, buy-and-hold contrarian investors should see tremendous upside in these securities.  However, an investment here is not without risk.  As Simon Constable and Robert E. Wright of the WSJ note, "BDI changes sometimes have little to do with changes in underlying demand.  For instance, a spike in prices might simply indicate the limited availability of ships in the area needed."  On the flip side, a drop in the BDI may not correlate to a drop in demand as much as it does to new ships hitting the water. 

Everything considered, if the global economy is recovering and the BDI continues its rise due to material demand particularly from emerging nations, spot-price shippers look to be a timely investment.  Of the two mentioned, at the time of writing, Baltic Trading Ltd. is facing less debt ($101.25M to $1.14B) and has less short float percent (4.60% to 14.90%), so it may be the more alluring option.

The Back-Door Approach

The back-door approach involves companies that offer shipping services.  As stated above, a rise in the BDI may not necessarily equate to increased demand but rather a lack of ships in general, or in a particular area.  Because building new cargo ships is an extremely time (it takes 2 years to build an average sized cargo ship) and capital intensive endeavor, some companies opt to conduct repairs on their existing fleet to meet a rising BDI instead of making the commitment to build more.  A company like Kirby Corp. (NYSE: KEX), stands to benefit from a rising BDI with respect to fleet repairs; it provides engine overhauls and overall repairs.  Also, because the company operates in the railroad, power generation, and industrial markets in addition to its marine operations, it is quite protected from the BDI's intense volatility. 

Another back-door firm to consider is Sino-Global Shipping America Ltd. (NASDAQ: SINO).  This company helps front-door shippers navigate China's ports with improved efficiency.  Because each of China's 76 ports follow different rules and procedures, international shippers need specialized information to bring their products to what will soon be the world's largest economy.  Although Sino-Global has not turned a profit the last three years, its 2011 net loss was 51.5% smaller than its 2009 loss.  Overall, an increasing BDI and a global recovery should result in Sino-Global becoming profitable.

The Intangible Approach

The intangible approach involves investing in securities that the BDI indirectly measures.  Firms such as Rio Tinto (NYSE: RIO) that extract and sell metallic ores and building materials should see their inventories diminish and profits surge with a high BDI.  However, mining stocks do not have great correlation rates to the BDI over the past year due to exogenous circumstances such as China's thus far successful initiatives to grow its own mining economy and rely less on imported materials.  Regardless, cargo capacity scarcity should serve as an overall boon to raw material companies because ships won't be booked unless agreements are made. 

All told, a global recovery should result in an increasing BDI which should help nudge the above mentioned stocks' share-prices upward.

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