Baltic Dry Index and Such

Sunday, Feb 3rd, 2008
1400 hrs

I truly know that I don't really know but it does help in trading if I'm at least
near the complex neighborhood of what is transpiring. The markets will speak the
rest and hopefully complete thoughts with grace. I could not care less if every
one of my thoughts derived by an amalgam-analysis of the ideas/opinion of several traders, economists, analysts etc.,) and further research are wrong. As traders,
let's realize that intellectualism and prognostication lies in the way of reading
what the markets are telling us. Let our decisions be data driven. All you should
care about is making money. If you're wrong, get out gracefully. That said, here's
what I'm thinking now :

The most the Fed can do is prevent a hard landing. Like it or not, we're going to
have to muddle through it. We will see the Fed fund rates around 2% in the next six
months. Mortgage equity withdrawals (borrowing against the appraisal of your home) that kept alive consumer spending in the recent past will no longer work as home values have plummetted. The debt crisis will spread out to other kinds of debt instruments. The US dollar will continue to decline. The counter trend rallies that
have taken place in markets of the past (without exception) have always been led by
the very groups that lead broad markets to down territory ie., financials and retail
in our case now. Bear markets have always had vicious rallies - we are in the midst
of one now. So how do we play it?

A hedge fund friend of mine turned me on to a single trade idea in the shipping
business. I then spent several hours yesterday talking to a few friends, including
a Shipping analyst and then several more hours of research to construct a potential
trade for myself. Before I get into the trade, let's start with the Baltic Dry Index
(6134, +1.35%). Wikipedia says this of the index :

The Baltic dry index is an index covering dry bulk shipping rates. It aims to
provide assessment of the price of moving the major raw materials by sea. Taking
in 40 shipping routes measured on a timecharter and voyage basis, the index covers
supramax, panamax and capesize dry bulk carriers carrying a range of commodities
including coal, iron ore and grain. These indices are based on professional
assessments made by a panel of international shipbroking companies.

In other words, its a good indicator of global trade. Right now it looks pretty beat
up with a nice counter trend rally in the past two weeks. Share prices are not in
lockstep with the index. Chinese Steel companies have stopped buying, waiting for
negotiations and companies in Brazil are now going back to production. Weather in
China recently has also played a part. Its not easy to short the index as a bank has
to write you a swap. The index itself is made of companies that quote prices. So
doing some rough snooping on the index itself I came up with a BUY list and a SHORT
list (as a hedge) for myself :

BUY : SSW, DAC, PRGN, OCNF, DSX, HRZ
SHORT : DRYS, TBSI, EXM, GNK

Common characteristics for the names on the long side : Yields in range of 8-12%,
12x Price to Net Asset Value, Predictable revenues two years out. Some of these will
act more like a bond than a stock. The names on the short side is a sort of weak
proxy for shorting the Baltic Dry Index. Will my trade work? I don't know for
certain. Nobody does! I'll probably find out if I do put on the trade...

In 1992, my home was the Rochester Institute of Technology, specifically the
Wallace Memorial Library - I spent the better portion of a whole year
concomitantly devovoring McConnell Economics, very old Wall Street Journals,
abstruse economic works by Karl Popper, Ludwig von Mises, John Kenneth Galbraith
and the ever persistent John Maynard Keynes. Alongwith notes from various economic
texts, charts of financial markets from different genres were marked up with what
you'd call chicken scratches.

When Rochester was bid adieu, I left my book (with an azure blue cover) on the third
floor of the library. Perhaps, some student picked it up after I left and looked at
it in bewilderment - my odd idea of an inspired prank. What I write in the next
paragraph is the result of much re-jogging of memory as well as research on
Wikipedia and other sources to make sure I have my memory correct.

In his foreword to the book "Extraordinary Popular Delusions and the Madness of
Crowds" by Charles Mackay, Andrew Tobias makes note, in eloquent verse, some of
the following facts - the stock market crash began in 1929 with speculation driving
the Dow Jones to the high 300s on the wings of greed. Three years later the
epitome of fear was represented by the level of the Dow Jones at 41. In the 60s,
stock prices once again began to rally with people brandishing what astute
management could make happen. Some stocks in the era went from the mid single
digits to over $135 a share in just two years! And then, very soon sold for
lesser than where it started...

Now wish me luck : This week, I hope I fail on all grounds in the jury selection
process. I'm going to put on the Alfred E. Neumann attitude : "What, me think!?"

- aLV

PS: The strict quantitative way of figuring out individual ratios involves finding
out what stock price movements constitute movements in the index. There are
several well known public domain methods of doing this. Read up on Eigenvalues
and Eigenvectors. You can write simple native Mathematica commands to do this.