For the unprepared buyers searching for wood this past week, their situation went from bad to worse. Scrambling turned into to chasing and then into panic. How else do you describe the markets when buyers look for the same items every day through the week?
The situation won’t improve as we head into the Christmas and New Year holidays. Most distribution wood is long gone. Import volumes at the ports remain light. Most mill lead-times are into 2022. Transportation remains an issue. Your options are limited and at today’s pricing, so is your budget.
At this point your “hope” strategy has imploded. You’re short on inventory. What do you do from here? Are you in or out?
In or out?
If you don’t have enough inventory to cover jobs through the end of the year, you’re in. If you don’t have a portion of your Q1 needs bought, you’re in. In means you haven’t done your homework and you haven’t been prepared. In means you still have to participate in this up trending market. Unfortunately for you, you’re going to have to endure some buying pain for the near term.
Your first priority is to make sure your inventory needs are covered until the end of the year. Go back and read last week’s post, we cover some ideas on what to do when you need to buy in these situations. It’s not easy and it won’t be cheap but you’re out of options. Time to swallow hard and get it done.
Next, sit down and formulate a buying strategy to get you through mid-January. Talk to your customers, review your computer sales and inventory reports, zero in on those must have items. Make the phone calls to your local distributors, reloaders, buying group, and wholesalers. Be proactive, stay in front of your inventory needs. Stay focused on market pricing and what you can afford. Keep your inventory light and turning until this market cycles back around to a buy mode. Work to average down once prices peak. Get yourself back to square one. Then you’ll be in a situation to develop a long-term purchasing strategy.
Now you’re asking, what about the outs? The outs are already out of this market and sitting comfortably on the sidelines watching this clown show of a market. Not scrambling, not chasing, no panic. The out buyer did his homework and had a plan.
Out buyers plan a month ahead, not 5 days ahead. Out buyers plan from month to month and quarter to quarter. Out buyers take advantage of opportunities in both the cash and futures markets. The out buyers biggest challenge right now is to determine what price level to hedge his inventory against the January and March futures contracts.
It’s time to step back and decide whether you want to be an in buyer or an out buyer. Do you want to be continually chasing the markets as an in buyer? Or be prepared as an out buyer to participate in the markets on your terms? Your decision.
Please note, when the markets cycle back around, and they always do, we’ll address this issue in the opposite context. When to be an in buyer to take advantage of product values and price opportunities. And, when not to be an out buyer and miss these cycle bottoms in prices.
Fundamentals
There has been a lot of commentary this week on the current lumber market and comparisons to the historic price run earlier this year. Some ideas well thought through, others not. The one point in common has been the steep price appreciation as demand is currently outstripping supply. On the other hand, there are definitive differences between today’s lumber market and the one we experienced last spring.
Early this year, pandemic concerns continued to weigh on the industry. Production capacity had been reduced due to Covid issues on both the supply and demand sides of the equation. As demand increased, production was slow to adjust. The surge in pricing last spring were demand driven. Lumber futures traded near or at a discount to cash. Strong fundamental cash demand was the driver to higher prices last spring.
Now let’s look at our current situation. Pricing ran countercyclical to historic trend. Seasonal lows usually occurred in mid-October. Not the case this year. Mid October saw pricing continuing to adjust lower. Pricing actually started to find support in early November into mid-November, right before expiration of the November futures contract. We had identified this cycle low in previous posts.
What precipitated this current price rally? Two disruptor events we previously addressed. The first was the BC harvest deferral announcement, the second was the deadly weather event in BC. Market reaction to the first was knee jerk buying ahead of a yet to be determined conclusion. This buying provided price support. The following weather event added the impetus to build upon the earlier buying. This short-term supply disruption underpinned the market. Transportation issues compounded the supply issue resulting in additional buying. This additional buying prompted price appreciation in the cash markets, and panic buying in the futures markets, as buyers attempted to lock in prices ahead of pricing they had experienced last spring.
Here’s the fundamental difference between both market events. Last spring, pricing rose on actual demand. Futures trailed looking for correction in the back months. Currently, speculative longs in the futures market are driving cash prices higher as mills attempt to balance the basis disparity. The large premium in futures is being used as additional leverage to force cash prices higher. The only actual demand in today’s market over the past two weeks has been panic buying. Unprepared buyers comparing last spring to now, afraid they will be left behind. Afraid that not another 2x4 will ever be produced.
This current market is dysfunctional. Mills pricing defensively and panicked buyers ignoring prices to own product. Mills going off the market with panicked buyers willing to pay premiums over market prices. Buyers issuing purchase orders to mills telling them to fill in their price. Unprepared buyers with no plan.
More dysfunction. Mills moving prices higher on lower volumes sold. Extreme price spreads from mill to mill. At one-point last week 2x4 #2 WSPF was being offered from $800 to $965 FOB mill. Establishing order files and higher prices a couple cars at time. We saw how that worked out last spring as unsold production accumulated. Speculative longs pushing futures prices higher. Basis spreads from -$120 to -$190. Has rational thought disappeared?
What happens when these speculative longs quit buying January and March? Who was buying the premium in January to EFP? We’re already seeing a decline in January open interest via the spread roll and liquidation. At what point do we see mills build legitimate order file by selling March and May? What happens to cash prices when futures roll over?
Lots of questions. You better be prepared and have a plan in place when this market corrects. Will you have a chair when the music stops?
Technicals
We covered a good bit of this week’s technical information above. Consecutive limit bid days continue to push prices higher. January is starting to liquidate positions ahead of expiration on the 14th. Cash basis remains on the extreme side. That said, this basis remains a very viable hedge tool when this market corrects.
Continue to keep an eye on the forward price curve. On the other hand, the March, July, and September contracts all made life of contract highs on Friday. Should July and September work higher, entertain the possibility of some short positions. Selling back month premiums this past spring proved to be extremely profitable for those that participated.
Dollars and Sense
Mortgage Bankers Association of America. Some good and not so good mortgage news this past week. On the good side, mortgage applications increased 2% for the week ending December 3rd. This was after a drop of 7.2% the previous week which was the biggest decline since February. Also on the plus side, the average fixed 30-year mortgage rate was marginally lower at 3.31% from the previous week at 3.3%. The previous rate was the highest since last April. And now the not so good. Although the refinancing rate jumped 9%, applications to purchase a home dropped 5%. According to MBA economist Joel Kan, “if rates trend higher as MBA is forecasting, the window of opportunity to refinance will continue to get smaller.” Seems rather obvious to us at B+P.
US inflation rate. I’m sure everyone saw the inflation news this week, but we had to include it in our post to let it sink in some more. The annual rate of inflation in the US continues to move higher to 6.8% in November. This is the highest rate since June of 1982! Although the Fed target rate of inflation was 2%, November marks the 9th consecutive month in which the inflation rate has surpassed that level. So much for transitory. Reasons? Here are several; a rally in global commodities, increased demand, wage pressures, the ever-present supply chain disruptions, and the low base to build on from covid shutdowns in 2020. More specifically, month over month gains were seen in energy costs, shelter, food, new vehicles, used vehicles, apparel, and medical care. We’re not economists here at B+P, just lumber strategists, but we fail to understand how the Biden administration, and their Build Back Better plan, corrects this situation? Common sense tells us it will only worsen this “transitory” inflation.
University of Michigan. No, we’re not going to talk about Wolverine football. Instead, we’ll take a look at their consumer sentiment number which increased to 70.4 in December. This is a positive number on two levels considering the market forecast was 67.1 and the November level was 67.4. The November number was a 10-year low. Both the current conditions and expectations components improved December over November. Of specific note, “the core of the renewed optimism among the bottom third (of household income distribution) was the expectation of income increases of 2.9% during the year ahead.” This will be something worth keeping an eye on in 2022 and its possible impact on inflationary trends.
Weekly economic calendar. Monday at noon, we’ll see the November Consumer Inflation Expectations report. Forecast is at 6% vs the October number at 5.7%. Rather bearish. Tuesday morning at 9:30, the November PPI figures will be released. Consensus and forecasted numbers are expected to be flat to higher. If so, not very encouraging. Wednesday, we see the weekly MBA mortgage information, the December NAHB Housing Market index, and Interest Rate Projections. All of these reports leading up to the always anticipated November housing starts and permit numbers to be released on Thursday morning at 9:30 am. Lots of information to review and digest this coming week.
PotlatchDeltic. Another forest products company taking advantage of increased product pricing. PotlatchDeltic announced on December 5th, a special dividend of $4 per share to be paid on December 31st of this year to shareholders of record on December 22nd. The company will also increase its quarterly dividend by 7.3% to .44. Expect to see this trend continue into 2022 as lumber and panel prices remain above historical levels.
BC rail service. Rail service in BC, by both the CN and CP, continues to improve from the recent weather event that caused massive flooding and transportation washouts. There is the expectation that the recovery will be measured as supply chain issues linger. BC mills are starting to move inventory build as empty rail cars begin to arrive on site. Of note this past week, one smaller volume stud mill in Williams Lake has started to schedule shipments on both rail carriers. We would expect the same to hold true for the larger sawmill operations in the BC Interior. It should be pointed out, although shipments are moving, it will take a bit longer to get back to normal volumes as other freight has priority over lumber. Priority freight usually means grains, oil, coal, and intermodal traffic. Some things never change.
Anecdotal Thoughts
Holmen Wood Products. Holmen announced this past week they will be investing SEK 400 million to upgrade their Iggesund sawmill complex. This investment will allow Holmen to switch from lower grade spruce production to construction timber in both spruce and pine. Production capacity is expected to increase by 20%. Start-up is planned for autumn of 2023 with full capacity to be achieved towards the end of 2024. The company will be investing in log sorting and a new planning facility. Holmen currently produces wood products at 5 sawmill locations.
Rail traffic. Some positive news from the Association of American Railroads. According to their weekly data, forest products originated rail traffic from Canada is showing a slight uptick in traffic comparable to rates in 2019. With additional loadings out of BC, from a back-log of sold inventory at the mills, car traffic could increase to year-ending origination levels from 2020. On the US side, car loadings are currently exceeding rates, by a rather large margin, from both 2019 and 2020. It will be interesting to hear what the mills have to say moving forward about car availability.
Timber sales. It would appear that the recent BC harvest deferral news is having a positive impact on US timberlands. According to RISI, a number of recent acquisitions, tentative deals, and several timberland marketing opportunities have been finalized or are in the works. Ruby Timberlands sold a 7,370 acres block in Washington to Schulenberg, while Langdale Forest Products bought 41,000+ acres in South Georgia. Both Timber Products and Shasta Forest are marketing properties in Northern California. Hancock Natural Resources is selling two blocks of tree farms in Texas and Louisiana, while Campbell Global is marketing a four-part block of timberlands across five states. Hancock is also engaged in selling a package of timberlands in Oregon and Washington. In the US South, Molpus has opened for bid 60,500 acres in Arkansas and Louisiana.
WWPA. September softwood lumber statistics from the Western Wood Products Association.
- North American lumber production dropped 4.2% year over year in September. Canadian production was down 9.1% while the US was off 1%.
- Operating rates increased in both the US and Canada month over month. US rates were up 2% to 81% while Canadian operating rates increased 7% to 78%.
- North American lumber consumption decreased 3.2% year over year in September with the US off 5.5% while Canadian consumption increased by 12.7%.
- US softwood lumber imports dropped 5.5% month over month in September. Canadian imports were 1.6% lower. Non-Canadian imports fell 24%.
- US log exports increased marginally by .5% month over month. Exports to China dropped 8.3% while logs exported to Canada gained by 17.2% and Japan a whopping 80.3%.
Zillow Research. In case you missed this, their Zillow Hot Housing Takes for 2022.
- 2022 will fall short of being record breaking. Zillow economists are anticipating both strong price growth and sales volumes. In addition, they are calling for 11% home value growth in 2022.
- Sellers will keep the upper hand. After years of underbuilding, supplies of homes will remain tight. Sellers will benefit from increased demand due to remote work, low mortgage rates, and bidding wars.
- Large rentals will be in high demand. Rising home prices will impact the rental markets, in particular, larger single-family homes.
- The “Sun Belt surge” will continue and expand to secondary markets that are more affordable.
- More GenZers and Millennials will buy a second home before a primary residence. The idea is to take advantage of remote work flexibility and not wanting to commit to a new location full-time.
- No end in sight for the renovation boom. As home prices and mortgage rates rise, many homeowners will upgrade their existing home rather than attempt to trade up.
- Work will play a key role in moving decisions. Zillow expects remote workers to continue to seek affordable housing markets.
- New construction gains only a drop in the bucket. There has been a shortfall of 1.35 million new homes since 2008 following the housing crash. Supply and demand will continue to weigh on the housing shortage until more housing supply becomes available.
The continued chasing of this market by the unprepared buyers made for a rather tedious week of trading. Unfortunately, those same buyers will be back again this week. More reason to read and understand our thought processes moving forward. Over the past two years, volatility has increased in lumber cash and futures trading. It’s more important now, than ever before, to be prepared and have a well thought out plan for the future. You can find us here every Sunday morning on Substack for a new edition of “It’s time to talk about lumber”. Subscribe and have it dropped into your mailbox every Sunday. If you have comments, questions, or suggestions, you can reach us at bandplumber55@gmail.com, or on Twitter at @MikeCla58829893. Have an industry friend or colleague? Use the share button below to pass along with our thanks. Until next Sunday, enjoy your week.