Collapse Or Opportunity?
What a difference a week makes. Most of the past 3 weeks saw rather lethargic purchasing activity as buyers bought to fill holes and balance their inventories. The overall plan was to wait out the mills and hope for lower prices. Finally, a hope strategy that seems to be working.
Lumber prices have faltered, cracked, and now appear to be collapsing towards that heavily discounted futures pricing that everyone so intently watches every day. Are prices falling with no end in sight? Is this current market headed to zero? We think not. Time to read on.
Collapse or Opportunity?
Collapse or opportunity? Maybe and yes. Prices are falling, but unevenly across species and markets. Until this drop in prices is more broad-based, we’ll refrain from using the word collapse. Is there opportunity in this price correction? Absolutely. Let’s look at both sides of this question.
We’ll begin with the price correction lower. Throughout this past week, I was hearing a lot of commentary about how lumber prices are “collapsing”. Became almost as annoying as the word “surge” when pricing is moving higher. When you look at the lumber complex across species and prices, you’ll hardly find a total collapse in pricing. About the closest you’ll get is SYP but we all know that SYP trading can oft times be more volatile than other species. Most traders know the reasons for this volatility; location, weather, product, fiber availability, shipping and market penetration. The production process and shipping schedules are more compressed than other rail focused species. I’m sure there are more reasons, but we’ll leave it at those. That said, SYP accounted for approximately 34% of North American lumber supply in 2021.
How about the other 66%? Did the other producing regions of North America experience a similar drop in prices this past week? The answer is no. Let’s take a look at the US West which accounts for 24% of NA lumber supply. The big loser there was GDF, primarily 2x4 and 2x6. But as we all know, GDF is sort of a niche product primarily focused on markets in the PNW and California. Coast HF, Inland Fir, and DF were all moderately lower except for studs. Species with a broader market appeal but again pretty much market specific. Aside from studs, hardly a collapse in overall pricing.
How about that big country to the north? Canadian production accounts for 39% of NA lumber supply. The price corrections here were more pronounced than the US West but not as deep as SYP. The main culprit with Canadian SPF is its close relationship with the lumber futures contract. For Canadian producers with any production to sell, they needed to show price adjustments to appease buyers that were tracking the discount in the futures contract. On the other hand, aside from studs and odd tally loadings, we’re really not sure where this past Friday’s RL prices came from considering the majority of mills still have order file and continuing shipping issues whether it be via truck or rail car.
Is the lumber market collapsing? On some items yes. Is the overall lumber market collapsing? We don’t believe so. After all, total NA sawmill operating rates haven’t been this low since 2016. Perhaps a cycle correction at this point versus a total market collapse. Can pricing go lower? Of course, they can. The bigger question is, how much lower?
Now let’s look at the other question. Does this market drop in prices present opportunity? Indeed it does. One only needs to go back to the end of January into the first week of February. Lumber prices were high and running countercyclical to trend. Everyone was waiting on lower prices to rebuild inventories ahead of spring business. Both cash and futures prices stalled and tipped over to the downside. The perfect opportunity for buyers to find a price level to step in and purchase some inventory.
Everyone started to ask how long the correction would last and how low prices would go. Looking back, it became an easy question to answer. Prices didn’t drop as far as most buyers had hoped they would, and the correction lower lasted all of approximately 4 days. Prices once again gained support off of this quick bottom and pushed higher. The majority of the industry missed the opportunity. Price consolidation lasted through February before buyers stepped back to assess their inventory positions for March.
And there they sat for the month of March. Most purchasing was focused on filling holes and balancing their inventory positions. Opportunity had been lost and prices were higher. Add in the ongoing transportation issues and most buyers were stuck. Although most had, or have product on order, a high percentage of these orders are late shipping to yards that are under inventoried. We’ve covered this in previous newsletters. Now comes a second chance to buy and rebuild depleted on ground inventories. Who will step up and take advantage of this opportunity and who will be waiting for pricing to go to zero and squander this second chance? Let’s move onto fundamentals.
Fundamentals
We’ve all experienced price fatigue, caution, indecision, and uncertainty over the past month. Demand was flat, trading activity slowed, and the industry continued to fret over the possibility of downside price risk. Everyone remembers last spring and doesn’t want to be caught holding high priced lumber. Inventory outtake and liquidation has been uneven with buyers relying on distribution and port trucks to keep their yard stocks balanced. Now what?
We’re beginning the last week in March with April right in front of us. Field inventories remain light, demand is solid and getting better, prices are falling, and the mills are looking for firm offers. If you’re a buyer, it doesn’t get much better than this. You need to build your inventory position for spring business, prices are dropping, and mills are asking you what you want to pay for a load of lumber. As we stated above, here’s your opportunity. It’s time to buy into value. Make the firm offers and book some lumber.
Why now? The last several weeks, we have seen a rather extreme disconnect between cash prices for lumber and the lumber futures contract. This disconnect became more exaggerated this past week as SYP pricing collapsed. This outsized effect on lumber futures from SYP helped open the door for overall price corrections across the entire lumber complex. Given the time of year, various lumber items are becoming a value, a purchasing opportunity.
Will pricing continue to drop or are we already finding purchasing support? The answer is yes and yes. We anticipate some residual downside price correction but have also seen increased buyer support from firm offers on heavily discounted mill offerings. Most in the industry looked at RL print Thursday evening on SYP and thought, what a deal. Perhaps they were but prices on firm offers Friday morning where already being taken by the mills $150-200 under print.
Participation so far has been rather widespread; stocking distributors, reloaders, office wholesalers, commercial jobbers, and co-ops. We would also expect to see treaters and truss manufacturers take advantage of lower prices.
Both truck and rail transportation issues persist. We don’t expect the situation to get better any time soon. Most of the SYP orders will ship by truck. A more difficult situation with produce season ahead of us as the rates for hauling produce are way more lucrative than hauling lumber.
How about rail cars out of Canada. Not much improvement. Checking statistics from the American Association of Railroads, transit times from their last report were flat. Even more discouraging, forest products originations continue to lag the seasonal pace for both 2020 and 2021. Pull up the website, these are railroad statistics, not mills or lumber traders telling you it’s getting better.
Even though it hasn’t officially been confirmed, it is believed that one large volume sawmill operation will continue with their 3-day production schedule through April as they continue to work through their backlog of late orders.
We also know of the headwinds working against the home builder and the DIY segment of the industry. I’ll tell you right now, we’re not housing experts, we follow lumber. That said, the home builders will not just stop building houses. They have a backlog of houses to start, new orders in the pipeline, and a low percentage of cancellations. Almost all of their customers are locked into lower mortgage rates.
On the DIY and R&R side of the business, there is an expectation of slowing activity due to macroeconomic events weighing on disposal income. This we’ll have to watch. On the positive side, more people are deciding to stay in their existing homes. With new and existing home prices continuing to increase, there’s an advantage for these homeowners to invest in R&R projects to further enhance the value of their homes. We will see.
Currently, there is a wariness among buyers as to how long, and how steep, this price correction will be. Don’t over think the situation. If you have a purchasing strategy in place, and need to buy inventory, now is a good time to get started. Now is the time to buy into weakness with firm offers. Now is the time to average down your inventory costs. Buying support continues to build as mills find a bottom to this price cycle. Better weather and longer days are ahead of us. Business activity is picking up and your inventory outtake increasing. Decision time.
Technicals
The disconnect continues between cash lumber prices and futures. Many traders kept asking the same question through the week, how long can this extreme discount last and when will it correct? The easy answer is it will correct when we achieve convergence. When, and at what price that will occur, is unknown. The one constant we do know, cash and futures prices will converge.
For the week ending this past Friday, the May contract dropped $177.30 on an open interest gain of 65 contracts. Of note, the May contract lost only 14 positions on the week. All 5 trading sessions settled lower. Obviously, bearish on the price drop, but a positive on the gain in open interest to 2654 contracts. The May contract experienced 2 limit down days, the first on Monday, the second on Wednesday. The November contract made a new life of contract low at $780. That’s worth watching to see if November can make additional lows here over the near term. The volatility continues.
Let’s go back and revisit the cash basis numbers for the week. The low basis number in May was +$271.70, the highest at +$345.70. July was even more extreme at +$437.40 and +$517.00. Is there value in these numbers? Technically, yes. The May and July contracts remain the least expensive option to purchase SPF lumber along the downward sloping price curve. For those of you that forward price jobs, these are real numbers. In our current lumber price structure, the fundamental strategy here is to buy the discounted futures and sell your cash positions.
Here is some technical data we’ll be watching to start the week. For the May contract, we’ll keep an eye on these levels of support; the 100-day moving average at $1007.01, the daily low from 3-25 at $974.80, the 50% Fib level at $953.15, and the price cross at the 40-day moving average at $952.90. Near term upside resistance is found at the daily close from 3-24 at $1020.00, the daily high from Friday at $1022.00, and the 38.2% Fib level at $1048.53. We’ll also be keeping a close eye on cash prices through the week for any firmness and downside price support. With daily trading limits at $57.00, and $86.00 on the expanded limit, the $177.30 price drop this past week could be erased in the blink of an eye. Please be mindful, we’re heading into the first week of April, the weather is getting better and the workdays longer. The expectation is for business to pick up now through May. Be prepared.
Dollars and Sense
US Census Bureau. February New Home Sales dropped 2% from January to a SAAR of 772,000. This was below market forecasts of 810,000. This was also after the January numbers were revised 8.4% lower. Year over year, the median sales price for a new home was $400,600 versus $362,000 and the average sales price $511,000 against $407,500 from 2021. Once again, tight supplies continue to drive up prices for new homes and in turn pushing more prospective buyers to the sidelines.
Mortgage Bankers Association of America. Another not so encouraging MBA report for the week ending March 18th. Following a 1.2% drop the previous week, mortgage applications fell 8.1%. Applications for refinance were off 14.4% while the purchase component was marginally lower by 1.5%. Mortgage rates jumped to their highest level in 3 years as the average fixed 30-year rate increased to 4.5%. We haven’t seen rates this high since 2019. We don’t have to tell you the expectation remains for higher rates through 2022.
Fed Speak. This past week, Jerome Powell mentioned the following in speaking to the National Association for Business Economics. If required, the Fed will increase rates by more than 25 basis points if needed when they make changes to the rate and continue to tighten above their prescribed neutral rate if necessary. Sounds like the Fed has quite a few adjustments left in their tool bag.
KB Homes. KB Homes reported Q1 results this past week. Their first quarter ended February 28. Although not up to estimates, the overall results were solid. Total revenues increased by 23% to $1.4 billion while their diluted earnings per share were up 44% to $1.47. New order value was up by 15% to $2.15 billion and their ending backlog value was up by 55% to $5.71 billion. Also of note, operating income margin was better at 12.2% and gross margins increased to 22.4%. Given industry challenges over the past year, it would appear KB is headed in the right direction. You can access their website for additional particulars.
GreenFirst Forest Products . Good news from the folks over at GreenFirst PF as they announced a profitable Q4 2021. This was actually their first full quarter operating its new forest products group acquired from RYAM. Some of you will also remember these mills being owned at one time by Tembec. GreenForest is currently operating 6 sawmills and a paper mill. According to CEO Rick Doman, “we reached profitability in Q4 and have successfully integrated the acquired operating mills. As cash flow permits, we intend to make strategic capital investments with the goal to reduce the cost of production and increase our production capacity.” It’s refreshing to see these mill operations back in capable hands. Additional information can be found on the GreenFirst website.
Redfin. From Redfin|News this past week, some key housing market data and updates from the 4-week period ending March 20. This information was collected from over 400 US metro areas,
- Pending home sales were 1% higher year over year.
- The median asking price of newly listed homes were up 15% YoY to $398,850.
- 50% of homes sold above their listing price which was up 39% from 2021.
- Homes that sold were on the market for a median of 21 days compared to 31 days last year.
- Active listings dropped YoY by 23% hitting an all-time low of 469,000.
Additional data can be found at RedFin.com. It appears rising interest rates and inflationary headwinds continue to weigh on the US housing markets.
National Association of Realtors. Pending Home Sales information released by the NAR was less than stellar. Per their report, February saw a 4.1% drop in Pending Home Sales. Of note, contract signings were lower by 5.4% for the 9th consecutive month compared to 2021. Reasons cited were lack of homes for sale, higher home prices, and increased mortgage rates. Seems to be a common theme for housing in 2022.
Economic Calendar. For the week ahead. Tuesday at 9 am we’ll see both the January S&P/Case-Shiller Home Price Index and the FHFA US Home Price Index. Wednesday brings us the weekly MBA mortgage report on applications and rates, while on Friday, the US Census Bureau will release its US Construction Spending report. We don’t anticipate any surprises forthcoming from any of these reports. Higher home prices, higher mortgage rates, and fewer applications should be expected.
Anecdotal Thoughts
Disruptor. As noted above, this past week we saw increased buying activity at lower prices. In fact, most volumes purchased were on firm offers at substantial discounts. We’re also in the middle of spring break for many traders, not to mention the annual Gold Club outings celebrated by the various FCTG companies. We have personally noticed the office absences this past week as we made our rounds. The question here is, if these trader absences will hinder, or disrupt, trading over the next 2 weeks. Lots of talented people out of their offices. Do prices continue lower, gain price support, or find additional buying to bounce off a cycle bottom? We would like to hear your thoughts.
CP Strike. Teamsters are locked out early Sunday morning, back to work Monday. We may be mistaken, but wasn’t that the shortest railroad strike in Canadian history? All of the bark and bluster from both sides leading up to Sunday, and then they reset and head to mediation. What did we miss here? Can anyone explain please?
Hedging. We posed this question on Twitter this past week to no response. So, we thought we would ask here and see if we can get some feedback. Are there any of our readers out there that currently hedge their SYP purchases? There is correlation data out there that supports SYP hedging in specific market instances. Curious to find out if anyone out there is taking advantage when possible.
Hedging Part 2. We mentioned this in our last newsletter and via Twitter. How many of our readers are signing up for the lumber hedging seminar in April presented by StoneX and Westline Capital Strategies? Lots of buyers and traders out there purporting to be futures followers, some even fancy themselves “experts”. If you’ve never attended and lack basic lumber futures knowledge, this seminar is perfect for you. Not to mention, it’s also a great networking opportunity with your industry peers. Sign up, you’ll be glad you did.
9’ Studs. We’re not sure how many of you out there keep a real close eye on 9’ stud trims. In particular, 2x4-104-5/8”. Over the years, we have found this trim to be a precursor to market movement, both up and down. In today’s current markets, 2x4-9’ trims are weak with mills looking to move accumulations. This tells us most contractor yards haven’t been buying many of these trims over the past month. This is the primary trim used by the majority of homebuilders. Make sure you’re watching price movement and availability on these studs. Once the mills make the deals, and move their accumulations, prices will stabilize and work higher. When 2x4-9’ studs start gaining in price, and availability becomes tight, you know the market is about to turn. Be prepared, not an item you want to short on if you’re a pro yard.
We would like to thank you again for joining us this week, your support is appreciated. Even though this market has taken a bearish turn, we believe it will be short lived as the demand side needs to replenish their on-yard inventories. 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. We expect this market to remain volatile into Memorial Day and perhaps a bit beyond. Also, another reminder for the StoneX lumber futures seminar coming up in late April. This seminar is for both beginners and those with futures experience. There is always something new to learn. In addition, it’s a great networking event with your industry peers.
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
Or check out the buttons below for comments, subscriptions, or just sharing our newsletter with a friend or colleagues. Your readership and engagement are appreciated. For up-to-date information and daily lumber topics, catch up with us on Twitter throughout the week. That said, we’ll be back again next Sunday to talk more about lumber. Until then, enjoy your week ahead.