Basis or baseless? | by Mike Clark from B+P

It’s time to talk about lumber

Good morning and happy Sunday. Another eventful week in the lumber industry behind us with a new one ahead of us. For me, it never gets old. Except perhaps, most of the participants. Of course, that will change as technology continues to overtake the pencil and paper crowd. Fortunately, most of us have learned to adapt.

It’s good to be back after a two-week hiatus of travel and a bout with the flu. That said, I was able to take some time to review and reflect on the past six months of writing this newsletter. You will notice one noteworthy change, the deletion of the “Dollars and Sense” segment. Not only was this portion of the newsletter time consuming to collate and write, but I found it to be more regurgitative in format than what I initially envisioned this newsletter to present to the reader.

You don’t need me to cover news you can readily source in real time throughout the week. Should I see information not so readily available, I’ll include in the “Anecdotal Thoughts” portion of this post.

Now that we have that out of the way, let’s turn our focus back to lumber and attempt to find some market direction over the near term.

Basis or baseless?

How important is cash basis versus futures in developing a strategic purchasing plan? I’m sure everyone that reads this post has a varying opinion. Is basis important to you, or just a baseless jumble of numbers every day that means nothing to you?

If you find basis unimportant and not a part of your purchasing strategy, then all we can say to you is, good luck. Keep floundering around trying to guess price direction and “hope” you’re right. If you don’t know how and why you should be following cash basis, engage someone on that short list of lumber risk management specialist in the industry. Don’t know any? Drop me a note and I’ll give you some options.

Why is basis so important? In simple turns, we have two options in sourcing your lumber needs. First is the everyday cash transactional market. You call a mill, wholesaler, distributor or reloader to buy lumber on the spot lumber market. Pricing will vary from item to item and vendor to vendor. Most of the time it can be extremely difficult to determine if you’re getting a good deal or not. Pricing is fluid and subjective.

Your second option is to buy a futures position. In this scenario, you’re looking to purchase a futures price at a discount to cash allowing you to lock in a less expensive price for your wood at a designated time in the future.

Once again, let’s look at this price structure in simplistic terms. Cash prices for WSPF lumber per RL on Thursday evening was $1055. Where does cash pricing go from here? The industry consensus is lower, but how far lower over what time frame? I’ll be the first to admit, I don’t know.

Now let’s look at three things we do know. Cash prices for the first week of July 2021 were ~$700. Will current price levels follow the pattern from last year? The answer is ambiguous, maybe, or maybe not.

Here’s the second thing we do know. At the futures close on Friday, you could have purchased a July contract at $769.70, a $285.30 discount to cash. If you have upcoming business you need to price, this $769.70 is a real price for future delivery. And remember, shipping schedules for EFP transactions can be negotiated. Formulating your purchasing strategy? Look no further than the July basis. Beginning Monday, you know you can buy wood over the next 60 days between $769.70 and $1055. Of course, both numbers are fluid, but again whatever that futures price trades at over the next 60, it is as real a price as cash.

The third thing we know about basis is at some point between now and July 15, these two prices will converge. We don’t know where or when, but they will. Why you ask? We have explained this before. Beginning July 1, the futures contract essentially becomes a sawmill with a two-week order file. At that point, if you need to purchase lumber, you choose the least expensive option whether it be cash or futures.

This is our 10,000-foot view. There is almost an endless list of other factors to consider when monitoring cash basis. We can discuss basis trading at a later date. Again, should you need professional assistance, let me know, I’ll shoot you over some contacts. Is basis important in understanding price direction? Absolutely! Is basis calculation a baseless, needless exercise in number crunching with no apparent benefit? Absolutely not! Understanding basis separates the winners from the losers.

Fundamentals

After a rather short rally in the cash markets, lumber trading has begun to lose both energy and momentum. Those twin culprits of indecision and uncertainty have once again crept back into the lumber industry.

It appears most trader’s concerns are focused on the ever-increasing economic headwinds of higher inflation and increasing interest rates. Both continue to weigh heavily on the US housing industry.

In addition to the macroeconomic issues, we’re also seeing ongoing bearish signals emanating from both the cash and futures sides of the lumber markets. With overproduction translating into excess supplies, SYP is unable to establish a trading level to slow ever lower prices. This lack of price support and traction has sent a clear message to the lumber industry. Until the SYP markets stabilize in price, the buyers of other species will remain wary of any rally in overall lumber prices.

On the futures side of the business, the extreme cash basis against the July contract we noted above, gives zero purchasing confidence to industry buyers.

Although demand appears to be somewhat steady as home builders continue to play catch-up on home completions, the R&R segment of the industry has been less than robust year to date.

We expect more of the same this week as most buyers will once again revert back to a liquidation mode in expectation of lower prices and ample secondary supplies. Of note have been better volumes of Euro wood arriving at the ports or in transit.

The fear of downside price risk from earlier this year, and the spring of 2021, will continue to weigh on buyers’ decision making through the summer months. At some point, the current disconnect in the supply/demand equation will correct and we will see lower prices as increased mill production eventually finds its way to end users in a timely fashion. Develop a purchasing strategy to include increasing availability across the supply chain. We believe the years lows are ahead of us.

Technicals

A rather uneventful week in lumber futures as we saw it as May liquidated in an order manner through the week leading up to expiration on Friday. There were, however, three things that caught our attention in trading this past week.

The most obvious was the collapse of May pricing at expiration. Even for an expiration session, the $84.00 drop was rather large, but not wholly unexpected. For those that have followed lumber futures for any amount of time, you can almost count on those traders that get trapped in their positions and are hoping, by some miracle, that the longer they wait to exit their positions, the least painful the exit will be. Friday trading witnessed those participants that always seem to over-stay their position right up until expiration. Unless you have a definitive reason for being in a position at the beginning of spot month trading, your open positions need to be liquidated and reconciled.

The second item of note that caught our attention were the 91 EFP’s posted on the week. As always, we would like to congratulate those participants with a purchasing plan that includes the use of EFP’s to round out their buying strategy. Why is this important? While the industry publication pegged cash pricing at $1055 Thursday evening, there were recent dips in the price of the May contract that afforded the astute buyer an opportunity to buy into value to average down their inventory positions. As recently as April 25, you could have purchased a May contract at $945.60, a $100+ discount to cash. Just 10 days ago, the May contract could have been bought at $980.00, a $75 discount to cash. And just 5 days ago on May 9, the May contract traded as low as $975.00. Of course, the chart swing low in the May contract was on April 12 at $829.30. We would expect there were buyers of the May contract from this swing low all the way up to that most recent April 25 low at $945.60. I don’t know about you, but having wood on order, with a pre-scheduled ship time, $100 to $200 under current cash levels is a damn good buy. Let’s all extent a hearty round of applause to those 91+ May EFP participants on a job well done! And by looking at the CME Daily Bulletin, there appear to be another 14 EFP’s to be added to the list. We’ll get you the final EFP count for next Sunday’s post.

The third, and most intriguing, note of interest for us was the ability of the July contract to maintain its extreme discount to cash over the last week of the May trade. In daily trading, Monday through Friday of last week, the average cash basis against the July contract was +$285.52. In our view, an opportunity to manage risk using the fundamental strategy here of buying the discounted July futures and selling your cash position. Remember, when the basis is a plus, buy futures, sell cash. When the basis number is negative, buy cash and sell futures, effectively hedging your cash position.

Beginning with trading tomorrow, July becomes the front month against cash until expiration on July 15. How will this front month basis react moving forward? Let’s begin tracking the process over the next 60 days and find out why paying attention to basis is so important.

One final note here on lumber futures. Over the next several weeks, the CME will be rolling out new structural changes being made to the current lumber futures contract. As the CME receives additional input from the industry on theses revisions, we’ll keep you posted. So far, the anticipated changes are encouraging, especially in how they will affect trading liquidity. More to follow on this in the weeks ahead.

Anecdotal Thoughts

Trucking. I’m looking for feedback here or your thoughts regarding trucking availability and rates. It appears that certain lanes are seeing additional equipment while others continue to struggle in procuring trucks. On our end, there has been marginal improvement. Is the trucking situation getting better or worse? We’re also watching rates as diesel fuel moved to an average of $5.56/gallon this week. Either way, moving freight isn’t getting less expensive and we don’t anticipate lower fuel prices for quite some time.

Rail. The same holds true for rail transportation, especially in Canada. The AAR shows loadings adjusting towards trend, but most mills continue to lament the struggle to receive empty cars in a timely manner. Transit times are also normalizing although they have not been as bothersome as limited loadings. We expect car service from the CN and CP to remain disjointed when it comes to lumber as other commodities can be moved in a more efficient fashion at better rates. We have touched on this issue before as the railroads focus on oil, grains, and intermodal business at the expense of forest products.

Studs. We touched on this subject several weeks ago in watching stud pricing. If you recall, we noticed increased activity, and higher prices, in regard to 9’ stud trims. Clearly a sign of increased pro yard activity. We even stated that 9’ trims are usually a precursor to market movement, either up or down. A quick look at studs this week indicates a flat to sideways move by 8’ trims while 9’ pricing begins to fade with better availability. Although this portends a drag on the pro side of the business, this may also indicate better than expected activity at the box stores given 2x4-8’ is usually their top seller to the R&R customer. Keep an eye on mill lists for any 2x4-8’ studs with the descriptor “BC”. Bar coded material for the box stores not taking their inventory draws.

SYP. This topic has come up with us over the last couple years but is becoming more frequent as SYP production and usage increases across US markets. The topic of conversation? The development of a separate SYP futures contract. For those following us on Twitter, you’ll notice we briefly discussed this topic yesterday with a couple regular lumber participants. We can tell you this conversation has happened with the CME over the past couple years. We would expect more of a focus on the development of a SYP contract after the current lumber contract structure is rolled out to the public over the next several weeks. Stay tuned.

Once again, thanks for reading our weekly post, we do appreciate your support. Our goal when starting this modest newsletter 6 months ago was to make an attempt to put real lumber and futures trading activity in front of you on a weekly basis. We wanted our format to be more thought provoking, not more of the same price tables and charts. Real industry issues that you face on a daily basis and our ability to face them together in a coherent, proactive process. We have always believed, the more information you have, the better decisions you can make.

As usual, should you have questions, comments, or suggestions, we can be reached on the following social media platforms,

10 Likes

A lot of things work well in theory!!!

10 Likes

Nice comment!!!

10 Likes
Welcome!

To get started

click "All channels"

to select what

interests you