Shippers Roundup: Baltic Dry Index Declines

I'll venture a guess and say that not many people spend their days sitting around thinking about the Baltic Dry Index (BDI). In fact, I'm sure that the average person on planet earth hasn't even heard of the BDI. But it's important for investors to watch this index, which greatly influences the stock prices of shipping companies. It's also widely followed by economists because it's seen as a leading indicator of future economic growth and production.

So what exactly is the Baltic Dry Index?
The BDI is a number issued every day by the London-based Baltic Exchange that provides an assessment of the international shipping prices for moving major raw materials by sea. It's a rationalization of the supply of dry bulk carriers (ships that carry commodities such as coal, grain, and iron ore) and the amount of cargo that is being moved in various markets. The BDI is determined by the supply of the dry bulk carriers and the demand from companies that need raw materials transported somewhere.

The Baltic Dry Index is important for investors because it helps measure the health of the global economy. This is because it measures the demand for commodities and raw materials that are shipped on dry bulk carriers, which are used as a component for finished goods.

If the index is rising, it's seen as a leading indicator of future economic growth. But if the BDI is falling, it's viewed as a leading indicator of future economic contraction. Importantly, the BDI is completely devoid of speculation. Dry bulk carriers are not booked unless a company has raw materials to move.

The BDI is also crucial for shippers. The higher the BDI, the more shippers generally get paid to transport cargoes. When shipping companies use spot contracts, they are hugely exposed to the BDI, and their stock prices often follow it closely. When shippers use future contracting, the companies agree to a fixed BDI price.

With that in mind, let's take a look at the recent performance of the Baltic Dry Index and some of the biggest shippers.

BDI performance
The BDI has declined dramatically over the past four years. After reaching an all-time high of 11,793 in May 2008 just before the financial crisis, the BDI now sits at just 1,787.

The Baltic Dry Index has also been highly volatile this year, and December has been no different. The BDI price pushed up to more than 1,900 before losing over 5% this just week through Thursday.

Baltic Dry Index Stock Chart by YCharts

So if the BDI was down more than 5% this week, did shipping companies follow suit?

Source: Google Finance.

Even though all three major U.S. indices closed up more than 3% for the week, shippers didn't fare quite as well. The nine shippers that I listed here finished the week down an average of 1%, helped lower by a declining BDI.

Frontline was one of the bright spots as investors continued to react positively to its plan to restructure and shift some debt and assets to a new entity.

Paragon Shipping finished the week down more than 6% despite announcing a new $8.2 million charter agreement for one of its bulk carriers.

It's important to remember that many of these companies are not solely dry bulk carriers, and many have other segments. DryShips' Drilling Rigs segment has grown drastically in recent years as the company looks to diversify its business, spurred by a declining BDI. But all of these shippers are still influenced by the BDI, and it's essential that any investors considering these companies understand the BDI and what it means for shippers.

To invest or not to invest?
Shippers are just too risky for me right now, so I'm going to stay away from all of these companies. But for the less faint-hearted, I believe there is opportunity now to purchase these stocks for cheap. If you're bullish on the state of the global economy, these shippers are certainly worth a look. If you'd like to take a look at a stock that our chief investment officer is bullish on and picked out for explosive 2012 growth, check out The Motley Fool's brand new report, "The Motley Fool's Top Stock for 2012." It highlights a company that is revolutionizing commerce in Latin America. You can get instant access to the name of this company -- it's free.