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Michael Baxter

Bull and bear: Baltic Dry Index hovers around 25 year low

Written by: Michael Baxter on February 7th 2012

Category: Bull & Bear, News

Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories: Baltic Dry Index hovers around 25 year low, Gross hits out at zero based money, German workers backlash is what we need. Companies in the news: Standard Life, Electrocomponents.

Baltic Dry Index hovers around 25 year low

The Baltic Dry index is used to measure the cost of shipping certain commodities.

It is calculated by taking the cost of shipping across 26 routes on commodities including coal, iron ore and grain.

The index hit its all-time high in 2008 – May 20, to be precise. At that point, the index reading was 11793.

Looking back, we can of course see that the indices’ strength was a sign of a bubble. Within six months, the index was down to 663, the lowest reading since 1984. But it slowly climbed back, hitting 4661 in 2009.

2012 has not been a good year for the index, and a few days ago it was down to just 647, a 25 year low.

All this begs the question: is the index a good predictor of commodity prices? And does its recent poor form indicate an imminent crash in commodity prices?

Well, bearing in mind it peaked in May 2008 at the same time as commodity prices, it is tempting to conclude no, it isn’t. If it totally failed to predict the crisis of 2008, why should anyone think it is a good forward indicator today?

There is another issue; the cost of shipping is largely determined by demand and supply. But just remember it takes time to build a ship. Of course,  during the peak of the boom in 2008 ship building was pretty active, so inevitably there was way too much supply when the global economy hit the buffers. Then in 2009, as things began to look better, we saw resurgence in ship building.

So, is it possible that the Baltic Dry Index is something of an irrelevance?

But then again,  on its own, too much supply may not  be enough to demonstrate why the index is currently so low. Maybe commodity prices have been kept up by speculators, and the low reading of the Baltic Dry Index is an early indicator of this. If that is so, the merger between Xstrata and Glencore may have come at the top of the market.

We may be entering a merger season in the mining sector, but equally, we may be about to witness a sharp change in the fortunes of the players in this sector.

What can be said is that this will be an interesting one to watch.

Gross hits out at zero based money

When they say it’s a new paradigm, it sounds like a cliché, or maybe it sounds like delusion. On 5th March, the UK official rate of interest will have been half a per cent for three years. It’s becoming old hat now. We are becoming used to interest rates that are either zero, or very close to it.

And we have of course, come to rely on low interest rates. It is quite scary to ask: what would happen if rates suddenly went back to the kind of levels we used to take for granted? Economic theory says the rate of interest is determined by the demand and supply of money. Rates are low if there is a lot of saving, but not much demand for loans.

But central banks distort the markets. Rather than let interest rates be set by the markets, they try to interfere.

And maybe  the rate of interest is now so low that the return on savings is simply too low for it to be worth the risk. After all, when interest rates are as low as they are, who is going to lend out money if there is a risk it may go bad.

This is one of the arguments made by those who want to see interest rates rise. Some say that by keeping rates so low, no one wants to lend. Bill Gross has made a similar argument many times. And today in the ‘FT’ he did it again. The investor, who just about rules the roost in the world of bonds, worries that, because the longer run rate of interest is pretty much the same as short run rates, there is no reason to lend. Banks make money by borrowing short and lending long. But because the Fed has declared that rates will probably remain at zero for at least another two years, the margin has all but disappeared. The yield curve – that’s the chart that plots differentials in short and long run interest rates – is virtually flat. And so, by keeping interest rates at near zero, central banks are choking off supply .

He is almost certainly right.

But that is another argument.

Because rates are so low, and assets, such as bonds, are therefore so expensive, other assets look cheaper in comparison. Central banks are hoping that equities will rise in value.

If you believe leverage is dangerous, but investment in return for a share of efforts is much safer, theoretically low rates are encouraging equity investment.

It is just that the theory doesn’t seem to be borne out by the facts

German workers backlash is what we need

They used to call it the British disease: Union unrest that is. These days, unions have less power, and the gap between those at the top of business and the rest seems to have grown.

But it seems many workers in Germany are not happy. Okay, not many people are predicting waves of industrial unrest, or strikes bringing industry to its knees. But workers are not happy, and their union reps are flexing their muscles.

According to a report on Bloomberg workers across Germany want a bigger shares of the German growth story (German Workers Demand 6.5% Increase in Pay ).

Maybe they resent the way Germany is pouring money into Greece, while they are asked to make cutbacks.

But here is the irony: if German workers got their wishes, and earned more, German consumption would rise, its imports would grow, and the Eurozone would be a more stable region. Then Germany would not need to spend so much money bailing out its neighbours

On this occasion, it seems that the unions’ wishes and economic efficiency are on the same side.

Companies in the news

Bull:   In today’s ‘Times’, Tempus looked at Standard Life. Sure the banking group has had a sticky few months, but Tempus rather likes the look of this one. It likes the share prices; it likes the fact that management are incentivised to boost profits (what’s that: a positive comment about pay being linked to profits?), and it likes the fact that automatic enrolment pension requirements may boost Standard Life’s coffers. And so, the ‘Times’ says: “buy”.

Bull and bear:  Meanwhile, in the ‘Telegraph’, Questor took a look at Electrocomponents. Shares are currently trading such that the forward earnings ratio is 12.1, yield is 5.1 per cent. The balance sheet is strong, and debt low. Questor also worries about the outlook for the sector, which Questor says is difficult to predict. And so it says: “hold”.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: Baltic Dry index, Bill Gross, Electrocomponents, German wages union unrest, Standard Life, Yield curve

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