Good Sunday morning. Wishing everyone a Merry Christmas albeit a day late. Although we have one holiday week behind us, we still have one ahead of us. What should we expect for this coming week? Busy? Slow? Uneventful? For those of you that have been in the lumber business for any amount of time, there is never an uneventful day, week, month or year. There is always something of importance happening in the world of lumber. Let’s get started!
Pundit or Participant
For the longest time, lumber occupied a rather quiet backwater of the commodity world. For most, it was an arcane world of lumberjacks, and something called a board foot of measurement. Most people understood that trees were cut down in the forest, shipped to sawmills and then somehow ended up in their local lumberyard as 2x4’s. All this seemed rather uneventful.
Then came Covid and the pandemic. Everyday life turned upside down. Most people were told to stay at home under lockdown. Wear masks and social distance. Work from home, stay at home. Lots of people had time on their hands and some extra cash from the government. Couldn’t really spend a lot out and about since most businesses were closed or on reduced hours. Since people had the extra time, and money, why not invest in some home improvements. We all know what happened after that. The “surge”!
With the surge, came more attention to lumber availability and prices. All of a sudden, everyone seemed to be talking about lumber. As pricing rose to historical levels, the financial world started to take notice. Price appreciation elevated lumber up through the ranks of the commodity world. All of a sudden, lumber was being talked about in the same conversations as gold, silver, and oil!
The higher lumber prices pushed, the more “experts” we found in the financial community. Lumber was the hot commodity, and everyone wanted to be involved, everyone thought they were an expert. Here’s our point. Over the past two years, we have seen more lumber experts, more lumber pundits, and more lumber talking heads. Lots of noise, little substance.
Now is the time to get back to basics. Start the New Year by culling out the pundits and talking heads. Get back to talking with the industry veterans you’ve always worked with and trusted. The everyday traders, the everyday market participants. Look for the facts, not the fluff. Lumber prices have once again pasted the $1000m price level. Who do you trust, the financial pundit or the industry veteran that can rattle off board footage numbers off the top of his head? We find the choice to be quite simple.
Fundamentals
What happens now? Remember, when everyone runs to the same side of the boat, it tips over! Let’s be prepared. Lumber prices on the cash markets are ranging from the industry index of $1015 up to $1200 depending on the mill and items of interest. This should be your first red flag. Ask yourself, how can random length 2x4 #2 SPF actually be trading in a $185m range for the same item from sawmill to sawmill? It can only happen in a dysfunctional market.
Red flag #2. How much volume are sawmills selling at each price level as prices escalate $50-100 at a time? Sawmills are not going to sell 50 cars at $990m if they know they can ask and get $1015. In reality, they probably won’t sell more than 10 cars at a price level before pushing prices higher. Higher prices on lower volumes of wood sold is not bullish. Our guess is sawmills aren’t even selling production at this time of year. If they’re selling lower volumes at higher prices, and not selling production, then most likely, some volume of production is being stacked. Remember, they make while we sleep. This scenario played out last spring. We all know what happened to prices then, it didn’t end well.
Flag #3. Rail service in BC is back to normal and supply will catch up to demand sooner, rather than later. Especially at these price levels. Mills didn’t stop shipping while rail washouts were repaired, cars were just rerouted.
Flag #4. Weather at this time of the year will revert back to the norm. Cold, wintry weather in the northern tier of the US. Stormy, wet weather in the South. Never changes, always happens. Both production and consumption will slow and gradually gain a point of equilibrium.
Flag #4. Holiday season is upon us and how much actual work gets accomplished in the last 2 weeks of the year? Not much. This pause in business stretches inventory while awaiting those increasing rail shipments out of Western Canada.
Flag #5. After reaching convergence with cash, futures is once again trading at a premium to cash. See our take on this subject below in the Technicals segment. We don’t find this price structure to be bullish.
Are there additional red flags out there in the markets you should be watching? Indeed, there are. Keep your eyes and ears open. Look for these subtle changes in market makeup. Talk to those trusted industry advisers I mentioned above. Filter through the noise. There will be buying opportunities and value ahead of us. Be in a position to recognize those opportunities and be proactive in executing your plan. Be a leader, not a follower!
Technicals
Although this past week was an abbreviated trading week, there were several items of interest worth noting. With spot month trading beginning on January 3rd, we continue to see liquidation in the January contract. The primary feature has been the long roll from January to March with some mixed two-sided trade. With the March contract trading at a discount to January, and higher cash prices over the short term, why not take the opportunity to add more value to your long positions via the roll. The expectation is for this exiting strategy to continue to avoid spot month increased margin requirements and no limit trading.
Although we did see increased volatility this past week in lumber futures, the open interest numbers caught our attention. From the close of Monday trading, to the session close on Thursday, total open interest gained one position. From 2,363 on Monday to 2,364 on Thursday. Technically, the lack of build in open interest is not bullish. This trend will be worth watching over the near term.
Also of note, after reaching convergence this past week, futures once again pushed higher to a premium over cash in both the January and March contracts. This is important given recent comparisons to Q1 of this past year. There is a distinct difference. Q1 of 2021 saw solid fundamental demand push cash prices higher with futures trailing. The opposite is true now. Higher futures pricing will continue to pull cash prices higher as mills use the higher futures pricing to justify mill cash increases. We have said this before, we do not see higher futures prices pulling cash higher as a bullish scenario. Fundamental cash demand drives prices higher, not speculative futures pricing.
For those traders looking for value this past week, several opportunities presented themselves. Convergence on Tuesday brought a daily low in January at $999.10 with the March contract making a daily low at $981.30. With cash levels reported at $1015.00 and higher, the perfect opportunity to forward price either contract, at a discount to cash, presented itself. Should cash prices continue higher, start the process of looking for mill EFP partners in the January contract. Once identified, discuss product options that the mills are willing to EFP. If you’re long March, consider your purchasing strategy. You may want to hold to forward price, or should the market lose strength, take your profit and consider your cash opportunities. Either way you’re ahead of the market.
On the flip side, with appreciation in the March contract the balance of the week, and a premium to cash, there is also the opportunity to look at basis trading or hedging recent cash purchases. Use the futures contract as it was intended to be used, as a risk management tool.
Where do we go from here? We expect to see another convergence of cash and futures at a higher price level before expiration on January 14th. This move will give us insight on the March contract and what additional opportunities may be available in the front month. Our expectation is to see the March contract work lower the further we get into Q1 trading. For this coming week, we’ll keep a close watch on basis in both the January and March futures contracts. Basis provides arbitrage, arbitrage provides opportunities.
Dollars and Sense
Mixed messages from the MBA this past week on US mortgages. Applications were down .6% for the week ending December 17th. This after a 4% drop in the previous reporting period. Applications to purchase a home were 3.3% lower while the refinance applications increased by 2.2%. The average fixed 30-year mortgage rate fell to 3.27%. It looks for now like lower rates will continue to offset higher housing costs. At what point will higher home prices push more potential homebuyers to the sidelines?
November sales of existing homes in the US increased 1.9% over October to a SAAR of 6.46 million. This number for the month includes single-family, townhomes, co-ops, and condos. Also of note, total housing inventory was down 9.8% from October at 1.11 million units. Compared to November 2020, the median home price was up 13.9% to $353,900. The expectation is for this number to continue higher into 2022.
According to the US Census Bureau this past week, November sales of new single-family homes were 12.4% higher than the revised October rate to 744,000. That was the good news. The not so good news is that number is 14% lower than the November 2020 estimate of 865,000. The SAAR of for sale inventory at the end of November was reported at 402,000 which represents a 6 and a half months supply of new homes at the current sales rate. The median sale price for new homes in November was $416,900, the average sale price was $481,700. We’ll have to see how increased mortgage rates, and inflationary headwinds, affect sales and pricing through 2022.
Economic calendar for this week. On Tuesday, we’ll see both the October S&P/Case-Shiller Home Price report and the October House Price Index. The expectation is to see a modest increase from both reports. Wednesday, the November Pending Home Sales report will be released, plus the weekly US mortage information from the MBA. This weekly report includes updates on the average 30-year mortgage rate, refinance applications and applications to purchase homes. With the expectation of 3 rate hikes by the Federal Reserve in 2022, we could see a preemptive move by applicants to stay ahead of the rate increases.
If you happened to miss these two reads this past week, they are well worth your time. The first one was authored by Ali Wolf, chief economist for Zonda and appeared in Builder Magazine. Zonda has developed a new metric in calculating housing affordability as potential homeowners migrate from different real estate markets in search of value. You can check out the particulars at builderonline.com/data-analysis/zonda. The second came from Tim O’Hara at Forest Resources Association and focuses on the impact supply chain issues are having on segments of the forest products industry not readily apparent to most industry participants. In addition to sawmills, the article reviews timberland management, paper & packing, engineered wood products, logging, trucking, labor, and maintenance issues across the supply chain. Check out forest2market.com/blog for more details.
Anecdotal Thoughts
The CN announced this past week that their BC rail network was returning to normal after system washouts from the November weather event in western Canada. According to the CN, productivity has returned to pre-washout levels in the province. Their BC rail network had been mostly shutdown between November 14th and December 4th as the railroad experienced 58 “outages” across 150 miles of tracks in their system. Now we’ll have to keep an eye on the number of empty cars BC mills will be receiving and how quickly loaded cars transit through the system to their destinations. Although mill shipments had not been completely stopped, it will be interesting to see how timely orders depart from the sawmills.
The Canadian federal government announced this week their intention to challenge the US tariffs/duties under the new NAFTA agreement. The government filed notice to challenge under Chapter 10 of the CUSMA. Chapter 10 allows for a request of a binational trade panel to rule on the dispute rather than being reviewed via the World Trade Organization. In August 2020, Canada had won a WTO case on lumber, but due to an appeal by the US to the WTO appellate body, the case now remains unresolved due to structural issues with the make-up of the appellate body. The US is the single largest buyer of Canadian softwood lumber on a global basis. We’ll keep tabs on this challenge as it works its way through the NAFTA process.
New sawmill and merger announcements this past week. The Teal Jones Group is looking to build a new SYP sawmill in Bossier Parish, LA. The mill will manufacture a range of dimensional and specialty wood products with an annual production capacity of 300 million board feet. In addition, the mill will generate revenue from the sale of residual fiber products to local pulp and pellet plants. Teal Jones has operations in BC, plus SYP mills in Oklahoma, Virginia, and Mississippi. Tentative start and completion dates were not announced at this time.
On the merger side, PotlatchDeltic entered into an agreement to merge with Loutre Land & Timber Company. In exchange for 51,340 acres of timberland in Arkansas and Louisiana, PotlatchDeltic will finance the merger through the issuance of 1.96 million shares of common stock plus the assumption of $6.6 million of Loutre debt. Contrary to most M&A news coming from the forest products industry, PotlatchDeltic is acquiring fiber supply as opposed to existing manufacturing operations. Will we see more of this type of transaction over the long term? Perhaps so, every mill needs logs for their sawmill operations.
Resolute Forest Products is indefinitely idling their Calhoun, TN pulp and paper operation. According to Resolute, the mill has incurred accumulated losses including a last 12-month operating loss of $62 million. This stoppage will also have an impact on their tissue business. Overall, the losses will also impact their balance sheet as their forest products segment of the business is challenged by the highest duty rate on softwood lumber at 29.66%. We’re not sure how this will eventually play out for Resolute, but we doubt they will continue long term with a money losing operation.
Northwood Pulp. Canfor’s Northwood pulp operation in Price George, BC will be taking approximately 85-100 days of downtime due to a furnace/boiler issue at the mill. The outage is to rebuild the lower furnace of its #1 recovery boiler at the mill. The approximate cost of the rebuild is expected at $30 million impacting 5-6% of the mills production capacity. The more important question for the lumber side of the business is what will be done with the excess of chips normally destined for the pulp mill. Chips are a revenue source, but sawmills do not store chips. Will there be some type of production curtailments at any of the Canfor sawmills in the immediate area? We’ll keep you posted.
This wraps up our conversation and insights for this week. We appreciate you taking the time out of your busy schedule to read, follow, and subscribe to our weekly newsletter. We believe there is value in what we have to say. As always, we’re looking forward to the week ahead and would like to take this opportunity to wish all a Happy New Year. It’s just about time to put 2021 in the books and jump into 2022 with both feet.
You will find us here on Substack every Sunday morning where we like to talk about lumber. It’s our business and passion. We look forward to any comments, questions, or suggestions you may have for us, feel free to be in touch. Or you can reach us at bandplumber55@gmail.com. You can also catch us on Twitter throughout the week at @MikeCla58829893. We enjoy discussing market trends and events with the lumber community on Twitter.
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