Posted on behalf of Mike Clark - Subscribe to Mike’s substack
Good morning and welcome to our first post for 2022! As always, thank you for joining us, we’re look forward to the New Year. Now is the time to clear your mind, get a fresh start to the year, and focus on a strategy to grow your business in the year ahead. Make the commitment. Let’s be proactive and market savvy. Let’s be a leader.
Surge or Slump?
What’s next, continued price surge or slump? We have said this before and will continue to say it again, if you don’t have a purchasing strategy in place for your business, you need to get started now! Otherwise, you’ll just flounder through another volatile year of lumber trading “hoping” the markets work in your favor. Hope is not a strategy. Hope doesn’t grow or build a profitable business.
The only certainty with the hope strategy is pain. Those of you that haven’t been following our posts, and that have been buying and chasing this market higher through December, know the feeling. You missed the cycle bottom in mid-November and have spent an inordinate amount of time, effort, and money trying to play catch-up. This lack of planning and proactivity has left you scrambling for inventory while lowering your profit expectations. You have stumbled through this market surge, and it’s been painful.
The big question we’re hearing now? How long will this price “surge” last? We’re predominately hearing this from those industry participants experiencing the most pain! Since Labor Day, the lumber markets have been off cycle through the fall and winter. Late November and December are historically times of inventory reduction. Not the case these past two months. In that time frame we have seen several disruptions in the lumber markets leading to continued forward buying. This eventually led to panic buying into the holiday seasons (Thanksgiving and Christmas) and now back to higher prices. Now what?
If you’re a reader of our weekly newsletter, you should already know our expectations for Q1 of this year. If you haven’t been a follower, scroll back through our previous posts beginning with November 14th. Our strategy, for those participating, has you well positioned going into the new year. We even offered advice to those not as fortunate to have a plan to help them get through this surge. That said, we are now anticipating a price correction, a slump if you will, mid to late January.
Our reasons for this price correction? Look no further than our 6 red flags from last week’s newsletter. Although prices have yet to consolidate, the level of sales activity has slowed over the past two weeks. Mills did not sell production, yet claim order files out to the weeks of January 17th and 24th. A real reach since most mills have difficulty forecasting two weeks out. Rail service is pretty much back to normal in BC, while basis traders aggressively market wood from their reconciled January trades. Reloaders and stocking distributors appear to be aptly stocked from previously purchased positions. Importers have wood in ports and in transit arriving over the next three weeks. Have you been watching the weather forecasts of late? Winter weather has arrived, cold and snow in the North, wet and unstable in the South. Spot month trading in the January lumber futures contract begins tomorrow with increased margin requirements and no limit daily trading. After convergence the week of December 20th, the January contract has once more moved back to a premium to cash. Market exhaustion and doubt are creeping into both the fundamental and technical sides of the industry. We continue to gauge market make-up and price structure. The market movement we have seen, in leaps and bounds, pushing prices higher, can be even more violent to the downside. Be prepared!
Fundamentals
The last time we checked with Canadian and US sawmills, they were still producing, and the harvesting of trees hadn’t been outlawed. The panic buying of lumber over the past month reminds us of the irrational exuberance we witnessed last spring.
It’s difficult to understand, especially since they make lumber while we sleep. Sawmills always have wood available to sell. Especially at these price levels. They make it, they decide who gets it. Will there be production and short-term supply issues? Of course, some anticipated, some not. What we’re trying to say here is, do your homework, develop a plan, talk to your industry experts, and then implement your plan. The prepared, proactive buyer stays ahead of the industry noise and hype. No buying rumor, no knee jerk reactions. Just a good fundamental purchasing strategy.
Where does that leave us now? As mentioned earlier, historical price movement since Labor Day has been countercyclical. Purchasing for spring needs normally occurs very late in December, or early January, as buyers begin to build inventory for anticipated Q1 business. At this point in time, we’re seeing most large volume businesses already stocked and well positioned for Q1.
What if you’re not one of the well-stocked? The first place to go is not the mills. With above market pricing, and extended lead-times (so they say), all you’ll be doing is adding to an already losing position. Our first recommendation is searching out those wholesalers that basis traded the January contract. In most cases, their inventory will be better priced and more readily available. At the same time, contact your local reloader and/or stocking distributor. Chances are, they will have either hedged inventory on the ground, or basis traded wood, either way, negotiate your pricing. If you’re within close proximity to a US port, try the Euro importers. The wood won’t come cheap, but it is usually available within 2 weeks.
What if you’re already competitively positioned price wise, but would like to build some additional inventory for spring? As we mentioned earlier, we anticipate a price correction later in January. You will begin to see the signs, prompt shipping trucks and cars, a bigger offer list, outbound mill sales calls, more competitive pricing, and lastly, the firm offers. All through this process is a buying opportunity. Now is the time to find value and buy into weakness! How much will pricing correct? We can’t say with much certainty at this point, but start off the buying at a measured pace and look for inventory turns. You should always be targeting a cycle bottom price level to start to build your position.
We will get into more detail under our Technicals section, but keep an eye on the March futures contract. With the big premium to cash, there is the opportunity to basis trade a portion of your spring needs. Should the cash/futures price structure flip, entertain the possibility of forward pricing the discounted contract and take physical delivery through the EFP process. At times, additional value can be found through the EFP process depending on the item, and the mills willingness to move available production.
Technicals
For those of our readers that don’t understand, or follow lumber futures, you’re missing out on enhanced profit potential. From December 6th to December 21st, the January basis to cash ranged from a -$191.70 to +$10.20. For the astute trader, you could have basis traded the January contract, and forward priced the January contract. In simple terms, your basis position would have gained a profit in excess of $20,000 per contract while the forward priced position, as of the close Friday, would be up over $15,000. Take the time to learn and understand these basic arbitrage strategies. If you’re not taking advantage of these opportunities, I’m sure your competitors are.
Beginning with trading tomorrow, the spot month January contract will trade with increased margin requirements and without daily price limits. We expect additional volatility up to expiration on January 14th.
Activity this week has been centered around spot moth liquidation, either through position rolling to March and/or the back months, or outright exiting of the contract. This rolling has narrowed the January/March spread into +$5.00. With price backwardation through September, we also saw the March/May spread begin to expand out to +$86.40. The back month spreads, through May/July, should be watched carefully as profit opportunities. Outright short positions in the back months are also of interest since the March, May, July, and September contracts all made new life of contract highs this past week. The closer the correlation to cash, or outright premium to cash, the more we like the opportunities.
Futures trading structure raised concerns for us this past week. Of note, trading on both Monday and Tuesday settled at limit bid at the expanded daily limit of $45.00. Both days also saw an increase in daily trading volume. Not a surprise given the continued rise in cash prices. What caught our attention was the lower daily trading volumes through the end of the week, and more concerning, the net loss of 15 positions in open interest by Friday. This lack of build in open interest is not bullish. We will have to wait for the next Commitment of Traders report for further scrutiny. In addition, managed money speculative long positions have created this futures premium to cash, not a bullish scenario in the overall market make-up.
Dollars and Sense
S&P/Case-Shiller. The S&P CoreLogic Case-Shiller Home Price Index was released this past Tuesday. On the positive, the Index, which covers 20 US cities, was up 18.4% year on year in October 2021. This was marginally below forecasts of 18.5%, and the third consecutive month the index has moved lower. On the not so positive side, 14 of the 20 cities reporting saw prices decelerate for the month. The national index, which covers the 9 US Census divisions, reported an annual gain of 19.1%. This is below the 19.7% level reported for September. It would appear we’re seeing a slight flattening in home pricing headed into the new year.
Federal Housing Finance Agency. Also released Tuesday was the November US House Price Index. This report covers mortgages guaranteed by Fannie Mae and Freddie Mac. The average prices of single-family homes in the US increased by 1.1% from October 2021 which in turn was .9% over the September level. Year over year, house prices were up 17.4% in October, but lower than the record 19.3% gain in July 2021. According to the FHFA, “the large market appreciations seen this spring peaked in July and have been cooling this fall with annual trends slowing over the last four consecutive months.” With so many real estate experts calling for a boom in housing in 2022, these reports will be worth watching to see if these predictions, do in fact, hold water. Time will tell.
Pending Home Sales. Wednesday brought us the NAR release of US Pending Home Sales for November. Not the positive report most industry experts were anticipating. According to the NAR, contracts to buy previously owned homes in the US dropped by 2.2% month over month in November. The market forecast was an increase of .5%. Ouch. Even more discouraging, this follows a jump of 7.5% in October. High home prices and limited supply of homes were cited as the culprits. We have mentioned on several occasions the detrimental affect higher home prices would eventually have on the housing markets. According to the NAR, “the market will see more inventory in 2022 and that will help some consumers with affordability.” That might be the case, but with three rate hikes anticipated by the Fed for 2022, coupled with the continued rise in inflation, higher home inventories just might not make the impact the NAR is forecasting.
Real House Price Index. According to First American Corporation’s RHPI, home affordability has dropped to its lowest level since 2008. Primary reasons cited were higher mortgage rates and the continued increase in home prices. These factors caused their Real House Price Index to increase by almost 20%. With the expected increase in mortgage rates in 2022, higher home prices, and less inventory availability, potential home buyers will find house hunting to be a challenge in 2022.
Economic Calendar. The US housing calendar is rather light for the upcoming week. On Monday, the November US Construction Spending report will be released, while on Wednesday we’ll see the MBA’s weekly US mortgage information from both this past week and the week of December 24th.
Anecdotal Thoughts
Barchart. If you missed it this past week, an interesting article on lumber futures by Andrew Hecht. His primary focus was on price volatility due to the illiquid nature of the contract. This in turn due to a lack of daily trading volume and open interest. Another point of interest was the fundamental side of the lumber industry and its issues with tariffs and ongoing supply chin issues. Mr. Hecht also pointed to 4 factors that he believes will contribute to increased volatility in 2022: interest rates, infrastructure spending, inflationary pressures, and continued supply chain issues due to covid. Check out this article in its entirety on Barchart. Always a good read from Andrew Hecht.
Better Homes and Gardens. Another interesting take on the lumber industry, and in particular, lumber pricing for 2022 by Better Homes and Gardens. Using a variety of experts, including those with close ties with the industry, they expect lumber prices to remain at elevated levels for the “foreseeable future”. Not quite sure what that means. Some of the reasons covered are a mix of old and recent events that have, and will keep prices, on the rise in 2022. Mentioned were the recent weather event in British Columbia, the mountain pine beetle infestation, wildfires in the Pacific Northwest, labor shortages in the industry, and transportation issues. We’re not so sure how relevant some of these will play out moving forward. Truck and rail issues caused by weather in BC are just about back to normal, the large volume of the pine beetle fiber has already been salvaged, wildfires occur every year with varying degrees of impact to the industry, most Canadian sawmills continue to upgrade and modernize toward more automation, and transportation issues will eventually work themselves out like they always do. The article also expressed concern over the new tariff rates on Canadian lumber and the impact they will have on higher prices for 2022. And we would be remiss if we didn’t mention their take on the back month premiums in lumber futures. We all know how that can work out! It’s a short read but we believe you’ll find it somewhat entertaining.
NAHB. Check out the NAHB’s Eye on Housing article by Robert Dietz covering “Construction Times in 2020.” Information was gleaned from the US Census Bureau 2020 Survey of Construction and reviews single-family construction times by various categories; owner land built by owner, owner land built by contractor, built for sale, and built for rent. Permit authorization times are included in the discussion. You can also find sales information at the conclusion of the article. Good stuff for those in the home building and/or real estate business.
CalculatedRisk. Looking for answers on whether housing inventory will increase or decrease in 2022? Pull up Bill McBride’s recent CalcultaedRisk newsletter on Substack for his take on housing availability for 2022. It’s a longer read, but well worth the time. Some charts, graphs, and loads of pertinent information to read through and digest. Have further questions? You can find Mr. McBride involved in industry Twitter discussions most days throughout the week, or check out CalcutedRisk.substack.com.
Redfin News. Take some time and hop on over to redfin.com/housing-market-update to get their take on the continuing rise in home prices. There’s lots of discussion on current home pricing and a look at why the industry is at new record highs. Their report covers the four-week period ending December 26th with data based on homes listed/sold in that time frame. Some of the highlights covered are median-home sale and asking prices, pending home sales, new listings, active listings, time on market, and more. Some really solid data covering the housing industry.
On that note, we’ll call it a wrap for this week. Once again, we appreciate you taking the time to read our thoughts and insights on the lumber markets. As always, you can find us here every Sunday morning on Substack (bplumber@substack.com), and through the week on Twitter @MikeCla58829893. You can also reach us at bandplumber55@gmail.com. Have likes, dislikes, suggestions, comments, questions? We’re here to help you learn a bit more about the lumber industry. Subscribe and we’ll email every post right to your inbox every Sunday morning. Or, click on the share button and pass along to friends, colleagues, and employees. Until next week, be prepared, be proactive, and look ahead for opportunities. Happy New Year!