The shipping index is rocking despite overcapacity

Posted 3/25/2012 by Emerging Money,
Traders are famously obsessed with the Baltic Dry index of shipping costs for its ability to forecast not only commodity trends but the outlook for manufacturing and the global economy. Its downward legs may not always be accurate indicators, but its upward swings are a lot more reliable.

When the Baltic Dry -- variously abbreviated as BDIY or BDI, depending on your trading screen -- goes higher, it tells you that demand for commodities is rising fast. This means more oil and coal that need shipped in a hurry and so there is no time to negotiate long-term contracts at normal prices.
Shippers charge extra for spot customers. This is the main factor that drives shipping prices higher. As spot customers settle into their new routine, they negotiate normal contracts and their overall pricing usually goes down.
Given the number of ships competing aggressively for long-term contracts, anyone with the leisure to wait around can probably find decent pricing to ship oil, iron ore, copper, automobiles, grain, bulk containers or anything else.
This means that when the Baltic is rising, economic activity is not so much "strong" as accelerating. But when it is falling, economic activity may be falling off -- but it may also simply be continuing at a high level.
This is happening now. Since bottoming out at 704 on February 22, the Baltic is now back at 874, having rebounded 24% in the last month.

Demand for commodities ( DBC , quote ) is picking up again. Emerging markets plays in shipping and the mining sector are catching fire: yes, that means BHP Billiton ( BHP , quote ), Rio Tinto ( RIO , quote ) and Vale ( VALE , quote ) are back in play.
All the shippers are ripping it up. We talked about Frontline ( FRO , quote ) last week on Fast Money. This stock is up more than 50% in the last three days.
At this rate, even the depressed Guggenheim Shipping ETF ( SEA , quote ) may recover its footing -- but only in the short term, until hunger for commodities plateaus again, spot contracts get converted into longer-term relationship and the rules of supply and demand reassert themselves. Stil, we have a long way to go. As recently as December, the Baltic was trading at close to 2,000 points, 130% above where we are now.