It’s time to talk about lumber
The only thing better than a long holiday weekend is the short 4-day work week that follows. For most lumber traders, this past week seemed unusually long as lumber prices remained under intense pressure to the downside.
Most industry participants point to a lengthening list of reasons as to why we’re seeing lower lumber prices. On our end, we like to keep the reason in its simplest terms, supply versus demand.
Of course, there are numerous ancillary reasons that contribute to the supply/demand imbalance in today’s lumber markets. We’ll address several of these reasons moving forward with this week’s conversation about lumber.
Short Week, Shorter Prices
There’s an old industry adage that states market moves are usually found on either side of a long weekend. For most industry participants, there was a hint of optimism as the calendar approached the Memorial Day weekend. Prices were flushing lower looking for a bottom with an anticipation of renewed R&R business to help jump start the summer building season.
Participants returning from the Montreal Wood Convention felt invigorated from the positive conversations they had been engaged in through the better part of four days. For most, business remained steady with supply issues keeping some semblance of market equilibrium.
Now that equilibrium is gone as lumber prices collapse across the species structure. SYP is no longer the price outlier as Canadian SPF and US species from the PNW search for price discovery in a race to zero. Or at least that’s the thought process held by most in the industry. This short work week has truly led to shorter prices.
Will we go to zero? Of course not, this isn’t the oil industry. Will pricing recover? Absolutely. Unfortunately, there are too many issues, on both the supply and demand sides of the equation, to see pricing elevate back to the levels we worked through this past spring. In fact, we anticipate more of a range bound price structure through the summer months and into the early fall.
As mentioned above, it all boils down to supply and demand. Sawmills will continue to over produce because that’s what they do. Increased production increases efficiency and in the process lowers unit costs. We all know the cure for overproduction is curtailments. And the sawmills have become even more adept at using this tool.
On the other side of the equation is demand. In our minds, this is where the real problem exists over the balance of the year and quite possibly beyond. We all know the issues here and how they impact business moving forward. And no, it’s not because of Putin or the prior administration.
The elephant in the room right now is inflation and all of the negative implications for business and the consuming public. Disposal income and personal net worth is on the decline. Most people are now more concerned about how they will stretch the ever-decreasing amount of paycheck left available to them versus increased mortgage rates and over inflated housing costs. In fact, most workers right now have a difficult time even pulling up their 401k and/or pension plan for fear of becoming nauseous. And let’s not forget those young new homeowners that have a greater concern, baby formula.
The mills will address the supply issue like they always have. The demand side is a more difficult nut to crack. With personal disposal income declining virtually every week, we don’t anticipate much of an uptick on the demand side.
Lumber prices will find support and a bottom to this current price cycle. One has to look no further than inventory over liquidation. That said, we really don’t see much on the current demand side to rebound back to the 4-digit price realm.
Until such point in time that the US economy can regain better footing, our expectation is for a lethargic pace to the home building industry to continue. Look for range bound trading ahead as the supply/demand equation resets at lower prices over the next several months.
Fundamentals
Slowly but surely, supply issues are gradually improving. Better car availability is being seen by some mills while others begin to work through the backlog of finished product stacked at various mill locations. Trucking remains hit or miss depending on the origin and destinations. Fortunately, most buyers have factored in the extra week or two to source trucks.
That said, the demand side of the industry continues to lean on the secondary distribution channel to cover immediate needs as most buyers remain in over liquidation mode to flush higher priced inventory through their yards.
The bigger question in our minds at this point is how well stocked is the secondary distribution network? By experience, we aren’t aware of that many distribution sources that have focused on keeping a robust inventory position to sell from. More importantly, there are even fewer of these operations that have any effective, structured hedging program to mitigate downside risk while managing their inventory positions.
As we mentioned in last week’s post, this combination of steady sales, over liquidation, and lack of adequate inventory replenishment will lead to a much-needed round of buying over the short term. This round of buying, coupled with improving supply, will gradually find a balance between supply and demand that will keep pricing range bound within a lower range of prices as opposed to what we have seen this spring.
We expect downside risk to moderate as there is less downside risk under $630 than $1200. We anticipate short pricing to slow over the short term. This isn’t the time to be overconfident in trying to buy the bottom of this current price cycle. Don’t be caught short. Prices are unstable and mills want firm offers. Time to name your price levels, cover some of your short-term inventory needs and gauge market strength over the next two to three months. There is no need to overbuy or any reason to run out of inventory and chase the market higher. Have a plan to cover your business needs.
For every move to the downside, there is an equal move back to the upside. This is what makes cycle markets and allows you to gain market share and increase margins. Although fundamentals are weak, this lower pricing will adjust higher. Be ready.
Technicals
As with the cash markets, this past week was also a short trading week for lumber futures. Although we only had 4 days of trading, we saw several significant features this past week. First, there was a continual build in Open Interest through the week. As we always make mention, we see a build in OI as a positive sign in trading. Increased participation leads to improved liquidity, this is a plus for all traders.
Second, there were 9 July EFP’s posted by the CME on Thursday. Why is this important? Two thoughts. First, it appears someone was anticipating their buy price of the July contract was a value compared against both current cash levels and current futures pricing. At this point, in hindsight, purchasing the July contract sub $600 would indeed represent value against the Thursday evening RL print of $630. Secondly, this tells me that the short side mill had specific product(s) these buyers needed and the mills undoubtedly were able to enter these EFP orders into their current shipping schedule. A win for both sides. The mill was able to sell and load cars while the buyer(s) will have well priced product shipping to them in a timely fashion.
Third. The July, September, November, January, and March contracts all made new life of contract lows this past week. This tells us buyers were finding value and opportunity at these contract levels relative to anticipated cash downside risk. We’re firm believers in trading off of both life of contract highs and lows when these opportunities present themselves. We’ll watch for confirmation this coming week.
Fourth. With the Friday close in July at $623.30, we have effectively reached convergence against the RL print price of $630. The lumber futures contracts trade on a net/net basis while there is usually a payment discount associated with cash purchases. Take 1% from $630 and you have the cash discount price at $623.70 versus the July futures contract at $623.30.
Fifth. Lumber futures have made the slow swing from an inverted price structure to a carry market structure. In simplistic terms, this indicates increasing availability of supply short term versus the expectation of tighter supplies and higher prices along the futures price curve. Should we see cash pricing move to a discount to futures, you can anticipate basis trade opportunities and less risk exposure in inventory hedging strategies. As with forward pricing, if you do not use basis trading as a purchasing tool, you’re leaving profit dollars on the table. If you need to learn about basis trading, drop us a message, we can get you with several industry experts to assist you through the process.
Do these five features mentioned above mean the lumber markets have made a short -term cyclical low? Perhaps. We will need to now focus on both the cash and futures markets this coming week to watch for confirmation. After all, according to the Commitment of Traders Report, Commercial interests were long while managed money was on the short side. Additional long Commercial interest, coupled with Fund short covering, will push futures pricing higher. Be prepared and be ready to act accordingly.
Anecdotal Thoughts
Fire Season. As we progress further into the hot, dry summer months, now is the time to start paying attention to the increased risk of fire season in both the US and Canada. Fire season occurs every year with some seasons worse than others. Be mindful of the effect on fiber supplies and mill operations. Fire disruptions can be just as effective as curtailments in reducing mill production.
SLA. With the new US administration, there have been various talks covering a wide range of trade topics, but so far, nothing on a new Softwood Lumber Agreement with Canada. Is this because of no plan or program being formulated by the current administration? Or is it because there is no equity agenda when it comes to the US forest products industry?
AD/CVD. The new AD/CVD assessed rates report by the US Commerce Department is expected to be released this August. The current combined rate currently sits at 17.91%. The expectation for the new combined rate is approximately 11.64%. Further details will follow concerning specific rates as they apply to specific forest products companies. Stay tuned.
US Duties. We don’t know about you, but we’re getting pretty tired of the endless media articles calling for the US government to abolish the current duties on Canadian softwood lumber. To be clear, the US government can not unilaterally abolish these duties without the consent and support of the US Coalition for Fair Lumber Imports. Period. Get your facts straight before publishing another inaccurate report on US lumber duties.
We would be remiss if we did not mention our debt of gratitude to those men and women we solemnly celebrate on Memorial Day. Without their ultimate sacrifice, we would not be able to enjoy the freedoms we have in the greatest nation in the world…Thank You! Once again, we would like to thank you for reading our weekly post. We continue to believe, the more information you have available to you, the better decisions you can make for your business.
As usual, should you have questions, comments, or suggestions, we can be reached on the following social media platforms,
- bandplumber55@gmail.com
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- Twitter @MikeCla58829893