It’s time to talk about lumber
This past week provided a look into the lumber markets over the next 60 days. We all know we’re fast approaching the spring building season. Weather is moderating and the workdays are getting longer.
What did we see this past week that can give us a glimpse into business activity for March and April? Most of the clues came from the demand side of the industry. Not so clear is the supply side of the equation. Now is the time to step back and examine the supply and demand timeline to stay ahead of the increasing volatility in the lumber market.
Outtake vs Output?
The next 60 days will be a balancing act between supply and demand. How to manage your inventory outtake versus the increasingly available output from the sawmills.
These past two weeks have made it quite obvious how unprepared and under bought the industry has been in beginning to build their spring inventory needs. As mentioned in our previous posts, the industry was once again fixated on pricing instead of market timing. As lumber futures prices collapsed, and cash pricing eroded, buyers began liquidating in earnest, anticipating a pre-spring buy in at lower cost levels. This scenario indicated to us there was a need to buy and build inventory. Everyone figured they would sit back and wait for lower pricing, convinced there would be an opportunity to buy.
As we said earlier, these buyers were fixated on price and not timing. On the other hand, the strategic buyers realized the opportunity in buying the heavily discounted March futures contract. We all know what happened next. As the majority of buyers were waiting for lower prices, the strategic buyers were purchasing at lower prices. Not in the cash markets, but in the futures market.
This was our first clue that buyers needed to step in to buy and build inventory for their spring sales commitments. The least expensive option to purchase inventory was pretty much ignored by the majority of the industry.
What we witnessed next was clue number two of what we need to watch for over the near term. We all saw what happened over the past two weeks in the cash markets. The predictable entry of the unprepared segment of buyers rushing into purchase their cash needs. Not to build inventory, but to replenish what they had just so recently liquidated in anticipation of lower prices. This segment of the industry remains behind the proverbial 8-ball, still needing to buy and build inventory.
The extreme discount in the March futures contract brought in opportunistic buyers. As this purchasing increased, more support developed under the weak cash market. As cash activity increased, more support was added by the underlying March contract. This is where we are today.
Is there additional demand ahead of us? Indeed, there is. Will the demand side purchasing continue? Yes, it will. Will pricing continue higher. Absolutely. Why? The majority of purchasing this past two weeks was a stop gap measure to get most buyer’s inventories to the end of February. How about March needs? Most of that purchasing is still ahead of us as seasonal dealer and distribution outtake increases. The greater the outtake, the greater the need to replenish. This isn’t new, it happens every spring. The difference? So little inventory has been built throughout the supply chain. Outtake equals purchasing, purchasing means higher prices. Be prepared.
That leaves us with the other side of the equation, output. You know what we say about supply, the mills always have wood to sell. Each with their own individual hierarchy of which customers are offered what production and when. That’s why some people see wood and others don’t. But don’t be misled, mills always have wood to sell.
That said, why do we have higher prices and less availability? We believe everyone knows the answer to that question. One word will suffice, logistics. You know the word and the process, moving lumber from the sawmills to the end users. Whether it be truck and/or rail, supply chain issues persist. There are numerous reasons for these issues and we’re confident you’re informed, so we won’t go into detail. What you do need to know here, these issues will begin to fade over the near term. Weather will improve, truckers will be back on the road, and barring CP labor unrest, the railroads will be back to running on schedule. Sawmills will get their allotment of empty cars ordered, train lengths will increase, and transit times will improve. All of this isn’t new, we saw this same scenario play out in 2018-19. These supply chain issues always work themselves out to some semblance of normalcy. This spring will be no different.
At these price levels, sawmill production and output will remain elevated. Product availability will improve with transit times. The lumber markets will revert back to more of a supply/demand balance over the next 60-90 days.
This brings us to the balancing act we mentioned at the start of this post. If you are a strategic buyer with a purchasing plan, you will be in a position to pivot when the markets correct. You have already been in the process of accumulating and building inventory through March and possibly into April. That said, you can now gauge market makeup moving forward and anticipate price corrections in order to adjust your inventory accordingly.
What if you don’t have a purchasing plan moving forward? In the short term, you can expect more of what you just experienced, less product availability and higher prices. You’re probably breathing a sigh of relief now that your February needs are covered. Of course, you know what they say, no rest for the weary. You might see a short market lull this week as the other unprepared buyers attempt to gather their wits about them, but rest assured, there is more price appreciation and volatility ahead. Be prepared or be ready to continue to chase this market higher.
Whether you’re prepared or not, your outtake of inventory will increase. Mill output will remain elevated, but supply chain issues won’t improve quickly enough to keep you adequately inventoried if you’re not planning ahead. How will you balance your outtake versus mill output?
Fundamentals
If we heard it once this week, we heard it a hundred times, production is accumulating at the sawmills. We couldn’t agree more. In December and January, as prices increased in chunks, we often mentioned the fact of mills selling lesser volumes while raising prices. The mills continued to push price ahead of production, and their inability to ship in a timely manner. This selling strategy invariably leads to overproduction against their order file. What production doesn’t get sold is stacked.
At face value, this reminds me of the old “wall of wood” scare tactic. Everyone was told not to buy, there is more wood to sell, there is more wood to ship, there is more wood in transit. Beware this “sky is falling” scenario. Auntie Em had better get to the storm cellar! In reality, we are all fully aware of the logistics and supply chain issues faced by producers across every industry. As we mentioned above, these problems will get themselves sorted out over time. The biggest issue now faced by the lumber industry is time. Sure, the wood is produced and ready to ship from the sawmills. The difficulty is getting that wood to the end user in a timely manner. Even if the sawmills would begin receiving more empty cars to load tomorrow, they still have a backlog of orders to ship ahead of new orders. The first orders to ship will be program and contract orders, then transacted EFP orders, followed by cash cars to top tier customer accounts. Cars will ship according to the mill’s customer volume profile. Whether they be old orders, or new orders, there are still transit times to destinations to factor into the time schedule. The supply issue will gradually improve, the need for wood by the unprepared buyers is immediate. Time is the problem.
Without production moving through the distribution network in a timely manner, the current volatility we are experiencing in the lumber markets will remain. Until we achieve a balance between end user outtake and sawmill output, prices will continue higher. This is simple supply versus demand. Only when wood starts flowing in a timelier manner will this equilibrium in supply and demand be achieved.
Now what? Builder business, coupled with the seasonal uptick in R&R activity, will stretch dealer inventories and keep prices on the rise. Those that missed the opportunity to buy a week ago and said, “I’ll wait”, will be back to buy at higher prices. This uncertainty and indecision will support higher prices until logistical issues correct.
We expect higher prices into late March, to early April, before sawmill transportation issues begin to alleviate and support higher field inventories. If you don’t have a purchasing plan in place, the next 45-60 days will be painful. Once the market does turn, you’ll then have a whole other set of issues to resolve. But keep in mind, buying that correction is more a function of timing, not price. Don’t squander this opportunity to at least work back to even.
Technicals
With cash activity on the increase, and the March contract trading at a discount, the expanded limit bid days were predictable for the week. Then came Friday and a rather eventful session of end of week position squaring. Although volume was on the heavy side at 1547 contracts traded, open interest gained only 9 positions. While March continues to liquidate ahead of spot month trading, the back months continued to build open interest. For the week, there was a total increase of 160 positions in OI. In our opinion, moderately bullish. Also of note, there were 24 EFP’s transacted on the week. We’ll discuss that later.
With the price structure change in futures, the March basis moved out to a +$59.00, while May expanded to a +$129.30. Quite attractive to both rollers and spreaders. If you’re in need of purchasing wood, the March contract is once again your best option at $1216.00 versus the RL price of $1275. The low on the day Friday was actually a better opportunity at $1204.90. Why not EFP? As noted, the pricing is a discount to current cash. Most mill order files are now the week of 2-28 or 3-7. Contrary to what the uninformed might tell you about forward pricing; you do not have to wait until expiration to resolve the transaction. See our note above, there were 24 EFP’s transacted last week. Those cars will undoubtedly be entered into the mills current shipping schedule. In addition, EPF tallies are normally much more negotiable than open market cash transaction tallies. Why wouldn’t you want to buy your tally, at a discounted price to cash, that will be shipping according to the mills current shipping schedule? We can answer that for you, the EFP is by far the better deal.
Let’s look forward to this week in futures. Does the price drop in futures Friday portend a price correction to the downside? We would think not. Why? Let’s use the EFP example from above. Cash business remains active with buyers requiring additional inventory coverage. Availability is difficult with extended order files. Now, let’s look at the March contract. There are 11 trading days until March 1st, at which time, the March contract essentially becomes a sawmill with a 2-week order file. Will you buy cash at $1275, or the March contract at $1216.00 or lower? We’ve already answered that question. Just as we saw 2 weeks ago, when prices corrected off the March discount to cash, we expect the March contract to regain upside traction this week as strategic purchasers buy the discounted contract in lieu of higher priced cash.
We don’t expect the kind of volatility we experienced last week but do anticipate futures strength to support solid cash prices. In addition, it appears the majority of those participants enduring the short squeeze last week were able to exit their positions. The March contract should now be able to stand on its own merits, to provide market direction, albeit at a less frenzied pace.
One other point of interest from this past week, the May, July, September, and November contracts all made new life of contract highs. Highlight this note. Once the March contract expires, transportation issues are resolved, and cash pricing seasonally fades into Memorial Day, selling these back months at their life of contract highs could provide short term risk management opportunities. Do your homework and be prepared.
Dollars and Sense
MBA Mortgages. According to the Mortgage Bankers Association of America, mortgage applications in the US fell 8.1% for the week ending February 4th. Both the purchasing and refinance indices were lower by 10% and 7% respectively. The average fixed 30-year mortgage rate moved from 3.78% to 3.83% week over week. Not unexpected as mortgage rates follow Treasury yields higher as the Fed attempts to rein in inflation. Will the Fed wait until their March meeting to raise rates? Perhaps. Will it be a quarter point increase, or as some industry pundits predict, a .5% increase? Either way, the Fed needs to react to their “transitory” inflation model.
US Inflation Rate. Not very encouraging news, but not unexpected. The annual rate of inflation in the US continued its climb higher to 7.5% in January. This was higher than market forecasts of 7.3% and the highest level since February 1982. Excluding the energy and food component, the CPI increased by 6%. Overall factors contributing to the increase are energy, labor issues, strong demand, and supply chain disruptions in getting product to markets. Couple this decrease in purchasing power, with the increase in mortage rates, and the housing industry appears to be facing considerable headwinds the remainder 2022.
Economic Calendar. A much more active economic calendar is on tap this coming week with several housing reports in the queue. Monday, the Federal Reserve Bank of NY releases its January Consumer Inflations Expectations report. Tuesday, the January PPI reports will be released by the Bureau of Labor Statistics. We’ll see the MBA weekly mortgage report on Wednesday morning at 7 am with the NAHB February Housing Market Index to follow at 10 am. Thursday, the US Census Bureau will report the January housing starts and permits numbers, and on Friday morning, the NAR will release its January Existing Home Sales report. Lots of housing numbers to sift through on Thursday and Friday. As always, we’ll keep a sharp eye on the completions number accompanying the starts and permits report.
Anecdotal Thoughts
Completions. Speaking of housing completions, several large homebuilders this past week made mention of their intent to scale back new home starts to focus on completing their backlog of houses currently in various stages of construction. Finally, some rational decision making by the homebuilding community. Perhaps now, they can get back to some semblance of construction scheduling that they can control, versus their current scattershot approach to the market.
CP Rail. No doubt, most of you are aware of the strike vote under consideration by the Canadian Pacific Railway. This strike vote is being conducted by the Teamsters Canada Rail Conference among their Locomotive Engineers, Conductors, Trainpersons, and Yardpersons. Voting results are expected by the end of February. The union has served notice with the Minister of Labour who in turn has appointed a conciliator/mediator to support the process. Labor issues include wages, benefits, and pensions. There cannot be a legal work stoppage within the first 21 days after the conciliation process has been completed. Those of you that have been in the industry for any length of time know that this posturing rarely results in a strike, and if so, the Canadian government usually legislates workers back to work to avoid any prolonged rail disruptions. We’ll keep you posted.
WWPA November 2021 Lumber Statistics. Are you a numbers nerd? Check out the WWPA website for their update on November 2021 softwood lumber statistics. You can review particulars covering North American softwood lumber production, operating rates, consumption, imports, log exports and more. Statistical information covers both the US and Canada. Lots of information and numbers to crunch and digest. Enjoy!
GreenFirst Forest Products. Effective with trading yesterday, GFFP is now trading on the Toronto Stock Exchange. GFFP is the newest “edition” of the old Tembec and RYAM operations. This includes 7 sawmills and a pulp facility. GFFP had previously been listed on the TSX Venture Exchange. Congratulations to management and staff for getting GFFP back in the equity big leagues.
China. Some recent notes concerning Chinese softwood imports. Both 2020 and 2021 saw an overall decrease in Chinese softwood lumber imports. The top exporter to China? Russia, accounting of 66% of total Chinese imports. Why the decrease in North American imports? First, higher prices/returns in the US, both on low grade and upper grades. Next, production and logistical issues associated with Covid and port congestion. Over time, it was easier and less costly to ship product into North American markets.
As lumber imports decreased, there was a shift to softwood logs. Why? Lower cost for unprocessed fiber, plus inexpensive labor in China to process the logs into finished products. That said, we’ll need to be cognitive of the increased availability of finished softwood lumber destined for US markets. Our expectation is for the second half of 2022 as logistical challenges fade. You’ll need to factor this into your purchasing strategy moving forward.
I don’t know about you, but we found this past week to be both exciting and exhausting. Of course, we don’t expect much to change this coming week as volatility will continue in both the cash and futures markets.
Stay the course and stick to your plan. Focus on your business. Stay engaged with the markets. Don’t be caught unprepared. The weather is beginning to moderate across the country and the days are getting longer. Three of the most active building months of the year are ahead of us. We’re here to help.
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
