In our previous posts, we had discussed the various reasons for a market correction from the high lumber prices at the start of 2022. If you haven’t been following us here at B+P, you may want to take this opportunity to revisit these prior posts to bring yourself up to date.
That said, although we were anticipating a market correction, we didn’t believe this move would be either lengthy or deep in nature. The fact of the matter is this price correction was even shorter in duration than what we had expected. There was some market weakness into the end of January, and the first two trading days this past week, and then we reversed course once again. Lots of people out there scratching their heads and asking why. Let’s get started and see if we can’t answer some of those questions.
Extreme or Expected?
Since the beginning of the year, the lumber markets have endured extreme volatility to both the upside and the downside. Countercyclical price trends, supported by a premium in lumber futures, sustained an upward price trend in lumber from the end of 2021 into the new year.
Some of this activity can be attributed to genuine demand for inventory as most buyers had followed the historical trend to liquidate into year end. Unfortunately, the bulk of this buying became more panic driven as lumber futures pricing expanded its premium to cash. The market misconception was higher cash prices had to follow the higher futures prices.
Perhaps a prudent strategy in a contango market structure but not necessarily in a backwardation futures set up as we witnessed in January. Especially when the January futures contract was being pushed higher by speculative longs, primarily managed money and non-reportable positions. Cash buying chasing speculative futures is not a rational purchasing decision. As we have noted in previous posts, this futures market make up was unsustainable.
We all know what happened once the January contract expired. As lumber futures traded lower on daily limit moves, cash traders looked to liquidate inventory and take a more neutral market position. This meant little to no buying in the cash markets as lumber futures corrected. Meanwhile, mills leaned on their order files as demand faded. Order files in most cases that were not as robust as the buying public was led to believe. Gradually, supply and demand worked towards a position of equilibrium.
As supply began to outpace demand, the inevitable occurred. Cash prices began to correct as mill order files shrank. On the demand side, the usual scenario played out as buyers anticipated pricing to go to zero. It never fails as buyers once again overplayed their hand. Everyone continues to liquidate inventory to buy the “bottom” of the market. The only issue with this scenario is the vast majority of buyers rarely find the bottom of the price cycle. Why? We’ve told you before. It’s not a function of price, it’s a function of timing.
As the demand side of the equation waited for cash prices to plummet, they completely ignored the extreme basis growing in the March futures contract. This past week saw the March futures contract settle the expanded daily limit lower on Monday and Tuesday.
Compared to the RL midweek pricing Tuesday evening, the March basis was at +$245.10. An attractive alternative to purchasing the $1180 cash level. Prior to the open on Wednesday, we noted on our Twitter remarks, the two critical levels of support under the market, the Fib 50% retracement level and the 40-day moving average price cross. Breaching these two levels of price support would only add to the massive cash basis in both the March and May futures contracts.
Any of our readers that follow lumber futures saw this price correction develop Wednesday morning. As the March contract broke through these technical levels of support, buying interest increased as forward buyers took advantage of the massive basis to lock in pricing for March business well under current cash prices.
While the masses of cash buyers were certain prices had to go lower, the strategic buyers, with a plan, were taking the opportunity afforded them in the futures market to purchase lower priced inventory. Once again, the unprepared are now back to chase and panic mode as both the cash and futures markets corrected back to the upside by week’s end.
Was the move to the downside unexpected? Not for those following our newsletter. Was the correction back to the upside unexpected? Once again, not for those following our newsletter. We had noted in prior posts, the correction lower would not be lengthy in duration nor deep in price. Our only miss this past week was both the length and depth of this correction was shorter than even we had expected. Nonetheless, those followers with a plan, and engaged with us on Twitter this past week, are now ahead of the market.
The lesson to be learned here is to embrace the volatility. Volatility leads to opportunities. These opportunities keep you ahead of the markets. Plan and be prepared. Don’t ignore these market extremes, expect these market extremes.
Fundamentals
In the past two weeks, we have seen cash lumber pricing track sideways, adjust lower, and now rebound back to the upside. What do we expect moving forward?
First, just because it’s February, and weather has adversely affected business activity, don’t forget the three most active building months are just ahead. Days are getting longer, and weather will continue to moderate. That said, we anticipate a strong spring building season beginning in March and running through April into the first half of May. If you missed this past week’s buying opportunities, in either cash or futures, be aggressive this week to get your February business covered and if you can, a portion of March.
We expect to see higher prices over the next 60 days. We also expect the occasional dip in prices to allow you to adjust your inventory balance as needed. The plan here is to be well inventoried into the first of May. Following the historical trend, we would look to liquidate a portion of your inventory heading towards Memorial Day.
Secondly, what’s your plan to build inventory? The logical step here would be to buy a portion of your inventory needs via the March futures contract and the EFP process. Heading into Monday’s trading session, the March contract remains a discount to firming and higher cash prices. Use this basis to your advantage.
Next, work the reloaders and stocking distributors in the secondary markets for quick shipping wood, while also working the mill direct side of the business for any prompt loading truck or car tallies. If you’re in close proximity to a port, contact your favorite Euro importers. You’ll need to build some inventory sooner rather than later as prices work higher.
Are you a user of SYP? Don’t let the lower RL prices fool you. Prices are in fact working lower in SYP, but these lower price levels are also attracting the treated lumber buyers and truss manufacturers. If you don’t stay ahead of these buyers, you will be chasing prices higher.
Other suggestions. Look for mill contract business on a PTS basis or a supplier you might deal with that actively basis trades wood. Canvas your supply sources and find coverage before pricing continues higher.
We will continue to encounter headwinds moving forward through Q1 and Q2 on the supply side. Transportation, both trucking and rail, labor issues at the mill level, fiber availability, and higher manufacturing costs will all weigh on the production side of the industry. It is expected that improvement will not be seen until the second half of the year.
Lots to think about through this first half of 2022. Do your homework, formulate a purchasing strategy, engage in a risk management plan, and be prepared. There will be additional volatility ahead.
Technicals
Speaking of additional volatility, you won’t see much more than you saw this past week. Both Monday and Tuesday traded down the expanded $45.00 daily limit on moderate volumes. In the process, we saw 3 March EFP’s posted and March basis expanding out to over $245.00. As noted above, March futures initially breached support on the downside at two key technical indicators on Wednesday, but that in turn brought in forward price buyers to lock in attractive price levels for March and April business. Swing the other direction and the March contract settled the expanded daily limit bid Wednesday, Thursday, and Friday. In total for the week, there were 12 March EFP’s transacted with total open interest dropping 26 positions. Although this is normally a bearish indicator, several of the back months picked up volume during the week’s trading.
Lots of questions and comments on Twitter this past week as to why the pivot, and reversal in futures, on Wednesday. The answer is rather simple as I explained to several followers. As Wednesday trading began, March prices were pressured to the low on the day at $900.90, a basis of +$279.10! That is a $279.10 discount to current cash levels. Let’s put this example in more perspective. After Wednesday, there were 18 trading days until March 1st and spot month trading. At that point, the March futures contract, in actuality, becomes a sawmill with a two-week order file. Your options then become; do you buy cash lumber at $1180 FOB-mill, or the March futures contract that traded as low as $900.90 on the day. In fact, there was ample time to buy the March contract on Wednesday anywhere from $935.00 on down to the low on the day. Your $1180 cash lumber would more than likely ship the wo 2-21 o/s from the mill. As we saw this past week, there were March EFP cars already transacted for delivery, more than likely shipping at the same time as the cash wood. It’s quite obvious which is the better purchasing option, and why the March contract reversed course in Wednesday’s trading session. The strategic buyers stepped in and bought opportunity and value.
The March close on Friday, at the expanded limit bid levels, sets Monday trading up as another expanded limit trading day. We expect that to happen since even at the expanded limit bid, March would still be under current cash price levels. This upside strength will continue as cash prices consolidate and move higher on better demand heading into the spring building season. Few people have their February inventory needs covered. Even fewer have any product bought for March business. This volatility will continue in lumber futures. You can either engage in using the lumber futures contract as a risk management tool, or you can continue to follow those that do and chase product and prices higher. Your choice.
Dollars and Sense
MBA Mortgages. According to the MBA, the last week in January saw mortgage applications in the US increase by 12%. This was the largest increases since July 2021. Applications to purchase were up 4%, while those to refinance were up a whopping 18.4% as consumers looked to renegotiate their existing mortgages ahead of higher interest rates in March. The average fixed 30-year mortgage rate moved from 3.72% to 3.78% week over week. This was the highest rate since March 2020. The expectation is for higher rates moving forward as the Fed increases borrowing cost against increasingly higher inflation numbers. We’re of the opinion this will put a damper on housing for the remainder of 2022 as costs increase across all components of homebuilding.
Economic Calendar. Another light housing report week ahead with the above-mentioned US mortgage report on Wednesday morning at 7 am. Thursday, the Bureau of Labor Statistics will release the January month over month, and year over year inflation rate. Consensus and forecasts are anticipating higher rates of inflation in both categories. Another headwind for the US economy as a whole and housing in particular.
Anecdotal Thoughts
AAC News. From the British Columbia deputy chief forester this past week, effective immediately, the allowable annual cut in the Okanagan Timber Supply Area will be reduced. The Okanagan TSA covers approximately 2.45 million hectares in the Thompson-Okanagan Region of BC. This is in addition to the proposed harvest reduction announcement made back in November affecting old growth forests in BC.
Softwood Lumber Duties. Preliminary duty rates for Canadian lumber companies, for fall of this year, were recently released by the US Department of Commerce on Monday. The new preliminary CVD and AD rates on Canadian softwood lumber will be revised lower from the existing 17.91% to a new combined “All Others” rate of 11.64%. Changes will also be made for 4 separate companies: Canfor, West Fraser, Resolute, and J.D. Irving. Additional information can be found by accessing the Department of Commerce website.
Euro Imports. Both Holmen and Stora Enso anticipate slowing lumber demand in European markets with additional business being done in the US due to higher prices. We would expect to see an increase in export production from Europe by most suppliers because of higher pricing available in the North American markets.
IBS. International Builders Show this coming week in Florida. It will be interesting to see who is in their offices this week and who will be traveling. Will the show have an impact on lumber purchasing decisions this week? Time will tell.
SYP. As is typical at certain times of the year, 2x12 SYP has become rather tight due to wet weather and the inability to access larger logs in the forests. We don’t expect the pricing situation to resolve itself any time soon for 2x12 given the extremely tight market in engineered wood floor systems. And as mentioned above, beware increased buying activity by treaters and truss manufacturers as SYP prices drop and early spring business improves.
It looks to be another exciting week ahead in the US lumber markets. We look for prices to continue to pivot to the upside as buyers scramble to build their inventories against better weather and the spring building season starting March 1st. Focus on the fundamentals and stick to your plan. Stay engaged with the markets every day. Be prepared for increased activity moving forward. Now is the time to act.
As usual, should you have questions, comments, or suggestions, we can be reached on the following social media platforms,
- bandplumber55@gmail.com
- bplumber@substack.com
- Twitter @MikeCla58829893