Another Sunday morning, and time to review and reflect on the lumber markets. We’re experiencing a market that is both disjointed and disconnected at the same time. Not something you see often in the lumber industry.
The more prices continue to tumble, the more questions are asked about the longevity of the drop and the depth of the price correction. With these thoughts in mind, are there opportunities and values in this current market situation? More importantly, are you ready, or not?
Ready or not?
You’re now thinking, why disjointed? Take a look around at the current overall price structure in lumber. SYP has gone from collapse to free fall. And it doesn’t appear the chute is ready to open in the near term. How about US Western species? Dropping, but at a more measured pace. Except for studs. Canadian SPF is a bit of a mix. Mills with order files and transportation issues are avoiding the fray and focusing more on shipping issues than price.
On the flip side, there are smaller mill operations that need to focus on order file and price aggressively. This all makes for a disjointed market. There’s no real order or cohesion to this current market situation. This lack of order weighs on the demand side of the business. Buyers become uncertain and indecisive. Most become paralyzed and don’t know what to do. For them, the easiest decision is to make no decision and continue to wait. The only common denominator in this market is price weakness.
How about the disconnect scenario in the market? One has to look no further than the CME lumber futures contract. Since the expiration of the March contract, the cash basis in the May contract has been as wide as +$350.50 and as narrow as +$193.00. Looking out to the July contract, the numbers are more extreme at +$517.00 and +$322.60 respectively.
Why such the wide disconnect in May? After all, there are only 30 days until the May contract expires on May 13th. And yes, it is a Friday. More importantly, there are only 20 trading days until the May contract begins spot month trading on May 2nd. Back to the initial question, why the discount. The simple answer is more sellers than buyers. The real answer, futures participants are anticipating the backlog of mill inventories will be shipping to customers, therefore shifting that inventory to the demand side of the business. The bigger question, will this shift occur between now and spot month trading?
What does this mean? At some point, between now and May 13th, there will be convergence in the cash basis. This is a certainty. Even more pressing is spot month trading beginning May 4th. Why? Beginning on May 4th, the May contract, in essence, becomes a “sawmill” with a 2-week order file. If you need to purchase wood, you can buy either cash lumber from the sawmill, or a May futures contract from the CME, whichever is the least expensive option.
Why is this important? The answer is fairly obvious. Almost everyone right now is looking for a “bottom” in lumber prices. Look no farther than the May contract from now until May 4th. Currently, the May contract is a $235.10 discount to cash. Will this discount remain, no. As noted above, convergence between cash and futures pricing will happen, we just don’t know at what price level. Either way, the May contract is giving us “future” guidance. Be aware and be prepared.
We all know this market will find a bottom. Over the short term, we expect that bottom to be found over the next 30 trading days. Prices will consolidate. If you don’t have a purchasing strategy to take advantage of these lower prices, now is the time to start.
Over the past week, we kept hearing the same question from mills and importers. It’s April and the spring building season is here, “why isn’t anyone stepping in to buy?” Valid question. Prices remain too high, prices continue to drop, prices going to zero, lumber buyers have enough inventory, or business is just so slow, nobody needs to buy. Take your pick, we’ve heard them all. Or we can just look at the obvious answer which is, the demand side is under inventoried and needs to buy for April and May business.
At this point, everyone wants to liquidate high priced inventory. Replenishment buying will only cover a fraction of upcoming business. We all know what happens next. Over liquidation against a fear of buying into a declining market. More gravel or pavement in the yard than lumber.
Lumber purchasing and pricing follow cyclical patterns. We’re approaching a downside in this current cycle. Last November, the markets hit a bottom in the price cycle ahead of expiration in the November futures contract. After a move higher into the new year, pricing became toppy and faltered. Lack of support saw prices slide lower through January. Again, another cycle bottom formed moving into February and a run higher to the $1400 top we just experienced. And now we’re in another market correction to the downside.
Take a minute and look back at your purchasing strategy, or lack thereof, since November. Were you a buyer in November at the cycle low? How about the beginning of February? Were you a buyer at that brief cycle low? Will you be prepared and be a buyer on this next price cycle low? Are you ready to make those firm offers and buy? Will you take this opportunity to buy value in a declining market? Prices aren’t going to zero and there’s improving business activity ahead of you. Are you ready, or not?
Fundamentals
Aside from the continuing drop in prices, not much has changed on the fundamental side of the business. In this case, we’re going to take a look at the demand side of the industry.
Here are several things we know. Due to ongoing supply disruptions across most US markets, plus historically high prices, lumber inventories across the industry remain light. In fact, the perception we get in our daily conversations is inventory levels are below normal given the time of year. Of course, normal is a relative term depending on who you are talking with. Suffice it to say, companies are experiencing different degrees of inventory anxiety.
Due to higher prices and ongoing transportation issues, we don’t believe there is much overall product availability across the distribution channels. We hear the same comments; stretched credit lines, purchasing restrictions imposed by management, limited availability of certain items, and something we’ve often cited in past posts, the lack of volume buying and inventory build.
These issues have become so acute, that we continue to find distribution sources only stocking those “A” list items with quicker inventory turns. In some instances, whole product groups are being avoided to preserve cash flow. We don’t know about you, but we’ve heard a lot of, “sorry, we don’t have that item right now” more than what we would have expected going into the 2nd quarter of the year.
None of this is new information going back to the fall of 2021. What is new, however, is the current full-blown drop in prices we’re currently experiencing. The increasing fear of accelerating downside risk has pushed buyers to the sidelines. That two-headed monster of indecision and uncertainty has gripped the markets. And the same question we’ve heard the last couple of weeks, “what da you think?”
We’ve said it before and we’ll say it again. Over the short term, we’ll continue to experience supply issues. Rail loadings and transit times are improving, but not as quickly as had been anticipated. Truck traffic is worse and really isn’t getting any better. That said, you will need to make sure your inventory needs are commiserate with your anticipated seasonal outtake. In our minds, there’s no need to load the boat, just make sure you have enough inventory to get you through the next 60-90 days. The second half of the year, we’re not very bullish.
The R&R side of the industry will be slower, but we do expect the home building sector to remain active until they can make a dent in their backlog of houses needing to get completed. Then a step forward to get back on schedule with their new starts. Housing will be impacted by inflation and higher mortgage rates, but as we have noted before, a good portion of housing that needs to get started has already been locked into lower rates. Housing will experience headwinds in the back half of the year, but for now their backlog of starts will keep them busy.
We also have heard the past several weeks of the collapse in SYP pricing. Granted, there is quite the disparity in pricing versus other species options. Keeping that in mind, it’s not the cure all for every buyer, market, or industry participation. Kudos to those that can make the switch, but a large part of the industry doesn’t have that option for various reasons. SYP will be the first to correct in price setting the tone for the establishment of a price bottom over the short term.
On the SPF side of the business, please be reminded of the production curtailments at both Canfor and West Fraser. They are the two largest volume producers in Canada of a product that can, and is used, in every US market. Until they can resolve their production and transportation issues, SPF availability concerns will weigh on the market.
Remain cognizant of market makeup and price structure. As mentioned earlier, it is extremely important to monitor these market price cycles. They can bring opportunity and value, but for most, pain and missed opportunities. Be prepared. These violent market moves in one direction usually translate into an equally violent price correction in the opposite direction.
Technicals
On the week, the May lumber futures contract saw a drop of $43.10 over the course of 5 trading sessions. The lone bright spot for the week was on Tuesday with a daily gain of $54.50. There was a moderate increase in total open interest ending the week at 2725 positions. The CME also reported 10 EFR’s on Friday. These are “exchange for risk” positions described by the CME as “the simultaneous execution of an exchange futures contract and a corresponding OTC swap or other OTC derivative transaction.”
Cash basis in both May and July remain quite robust at +$235.10 and +$322.60 respectively. As mentioned above, we expect that to change over the next 30 trading days. Also of note, the May/July and July/September spreads narrowed to their lowest levels since the expiration of the March contract.
The futures markets focus on price discovery. Currently, the lumber futures contract is in backwardation with a downward sloping price structure. That said, lumber futures are currently the least expensive option to purchase lumber. We often get pushback from some of our readers regarding this statement, but in actually, the fundamental strategy right now is to buy futures and sell cash.
You would also be wise to monitor the back month prices and compare to their cash levels from those same time periods in 2021. An example here would be the July 2022 contract closing at $877.40 on Friday compared to cash pricing the first week of July 2021 at $700. Currently, the July contract is a value versus $1200 cash today. Not so much the value versus $700 last year.
Looking at the Commitment of Traders report, we see Producers adding to both their outright long and short positions, while their net position actually edged lower. Managed Money saw a decrease in their long positions and a sideways move in both their short positions and spreads. Their overall net position was lower. There was little change in Swap Dealer’s positions except for a decrease in their spreads. Non-Reportables have a marginally higher long position, a drop in short positions with a net overall increase. The Non-Reportable segment of the trade has become much more prominent over the last several months. That said, they also represent the most volatile segment of the futures trade.
A quick look at the technical numbers for the week ahead. Key resistance levels are quite scattered at this point. We have the 3-31 daily close at $965.30, the 4-1 daily high at $984.80, and then we move higher to the Price X 9-day MA at $1008.46, the 9-day Ex. MA at $1024.20 and the 100-day Ex. MA at $1028.43. Support is found at $953.15, the Fib 50% level, the 200-day Ex. MA at $937.09, and the 1 month low at $929.50. For those that follow candles, there was a spinning top candle left on Friday’s chart. Reversal? Perhaps, we would need to see 2 days of confirmation. Expect the daily volatility to continue.
Dollars and Sense
Standard & Poor. The latest S&P CoreLogic Case-Shiller 20 City Home Price Index was released this past week. As was expected, home prices continued higher by 19.1% in January across all 20 cities tracked by the Index. This is the largest percentage increase since September. This also beat industry forecasts of 18.4%. According to Craig Lazzara, Managing Director at S&P DJI, “We may soon begin to see the impact of increasing mortgage rates on home prices.” Quite profound, who would have figured?
FHFA. According to the Federal Housing Finance Agency, the average price of single-family homes with mortgages guaranteed by both Fannie Mae and Freddie Mac was 1.6% higher in January versus a higher revised increase in December. This was the highest increase in 7 months. The year over year increase in January was 18.2%. From the FHFA’s Division of Research and Statistics, “The mortgage rate shift has not dampened upward price pressure from intense borrower demand and limited supply.” Wow, a pretty robust statement. Especially when they use the word, intense!
Mortgage Bankers Association of America. The weekly MBA numbers for the week ending March 25th had a positive, and a couple negatives. On the positive side, applications to purchase a home were marginally higher by .6%. A look on the negative side showed us that applications to refinanced dropped 14.9%, the lowest level since May 2019. Combined, applications were off by 6.8%. Complicating matters was the 30-bps increase in the average fixed 30-year mortgage rate to 4.8%. This is the highest rate since December 2018, while the 30-bps jump was the most since February 2011. At what mortgage rate will the purchase applications fall into the negative per week? Stay tuned.
BEA. The Bureau of Economic Analysis this past week released their US PCE Price Index annual change. Needless to say, the numbers were not encouraging. For February 2022, the personal consumption component of the index increased year over year by 6.4%. This denotes an increase in prices of goods purchased. The services segment reported at 4.6%. Two primary features of note, energy prices were up 25.7% while food prices increased 8%. The annual core PCE inflation number was up 5.4% from 2021, the highest since April 1983. This is the Fed’s preferred measure of price changes. It would appear this perky inflation trend will be more persistent than what the Fed had anticipated.
West Fraser. Notice has been given by West Fraser of a conference call to discuss Q1 corporate results. On Friday, April 29, West Fraser will hold a conference call for analyst to review and discuss the companies Q1 2022 financial and operating results. The call will be chaired by Ray Ferris, President and CEO of West Fraser. You can participate by phone or webcast, go to the West Fraser website under News Releases for additional details.
US Census Bureau. US construction spending in February was .5% higher than January at a SAAR of $1.704 trillion. This was below market forecasts of a 1% increase. Spending on private construction increased .8%, mostly due to single-family home construction. Private residential construction spending was reported at $850,625. This is a new all-time record for February, up 1% month over month and 16.6% year over year. We’ll chalk that up in the positive column.
Economic Calendar. Except for the weekly MBA report on mortgage applications and interest rates, housing news is pretty quiet. As always, we suggest you visit Trading Economics for more detailed economic news, covering a wide array of topics, on a daily basis.
Anecdotal Thoughts
Canfor. Just in case you happened to miss the news release last Wednesday evening, Canfor announced reduced operating schedules at their Western Canadian sawmills effective April 4th. Reasons cited were the “cumulative effects of the unprecedented global supply chain crisis”, and their need to address an increasing inventory build at these sawmills. This new schedule will remain in effect for a minimum of 4 weeks as the company reviews and adjusts production. According to Canfor, this reduction in operating schedules is anticipated to impact a minimum of 100 million board feet of production.
West Fraser. Continuing on this same topic, West Fraser has been operating their Canadian sawmills on a reduced 3-day work schedule for pretty much the same reasons given by Canfor. This reduced schedule was slated to end by April 4th. Since we haven’t heard any official announcement by West Fraser, we would have to believe, by default, that their 3-day production will continue to remain in place until further notice. If we see an announcement from West Fraser, we’ll be sure to pass it along.
Tolko. Why stop with Canfor and West Fraser. Tolko continues to tell their customers their Lakeview Division (LD)remains behind, by up to 3 weeks, in shipping existing orders. Any production curtailment decision by Tolko is different than Canfor and West Fraser since Tolko is a privately held company. The mechanics to curtail may be different at Tolko, but the problem remains, their Lakeview Division is not getting enough empty cars to load. We will be following to see what Tolko’s next step might be in addressing this transportation issue.
Price History. As lumber prices continue to retreat to the downside, the continuing question remains, how low? We took a quick look at the daily price history over the past 1 and 2 years to look for some guidance. In the past 2 years, daily lumber prices have been in a range from $500 to $750, 34% of the time. In that range, daily prices have averaged $650 11% of the time. Switching to the 1 year, 30% of the time, daily prices fell in a range of $750 to $1000. That said, over the course of the 1 year, the highest percentage price average was 15%, once again at the $650 price level in the $500 to $750 daily price range. Need a comfort level to build some inventory, keep an eye out for that $650 price level in the long term for 2022.
Euro Lumber. Just a quick though as we keep hearing about the economic sanctions imposed on the Russian economy. In the bigger picture, what happens to the Russian lumber normally exported to Europe, and any other country, currently sanctioning the Russians? Quite a bit of discussion has centered around the debate that more Euro lumber will remain in Europe as opposed to being exported to the US. Currently, there doesn’t appear to be much disruption in Euro order flow to the US. Just thinking, perhaps Europe is contending with more pressing issues such as inflation, higher oil and gas prices, decreased availability of said oil and gas, and their having to pay for any Russian energy imports with rubles. Appears the Europeans hitched themselves to the wrong horse.
We would like to thank you again for joining us this week, your support is appreciated. Be alert. There are massive price ranges on particular items and across the various species. Know what is in your best interest. Are you able to switch species, and if so, what items? Have your purchasing list ready and firm price levels in mind. This market remains a firm offer market, sellers don’t want to see inquiry, they want orders. As always, be prepared and have a plan. Be proactive and control your own purchasing decisions. Take the time this week to talk with those people in the industry that you trust, review market structure and direction. Volatility will increase until a bottom is formed.
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