Whether to Buy | By Mike Clark at B + P

Andrew_Gibson · March 13, 2022, 3:20pm

It’s time to talk about lumber

After several weeks of hectic trading in the lumber markets, activity was rather subdued this past week. It would appear most of the industry took a step back, and a deep breath, to decide what to do next.

Indecision and uncertainty have once again gripped the demand side of the business. You have the ongoing Russian invasion of Ukraine, increasing fuel prices, higher inflation, and an impending interest rate hike from the Fed.

When you look around the industry, it feels like we’re at a tipping point. Or are we? Is this current pause in the market lulling everyone into a false sense of security? Is there more upside to this market, or are prices ready to adjust lower? Let’s take a look.

Whether to buy or Weather to buy?

I know, it’s a corny play on words. Couldn’t help myself. There is, however, some truth to the statement. The more we talk with people around the industry, the more we’re convinced of the fact that most are not under bought. Quite the contrary. It appears to us, most of the industry has product purchased to build a portion of their spring inventory needs.

On the other hand, we can see every day how under inventoried the market remains. The issue now is the inventory is in the wrong place, the wrong location. Ample inventories have been purchased but instead of the wood sitting in reloads, stocking distributors, or retail yards, the wood remains bottled up at the mill level.

Here in lies the most problematic issue facing the demand side of the industry. We addressed this in a prior newsletter. As weather continues to moderate heading into the spring building season, will there be enough inventory in the distribution pipeline to keep up with inventory outtake at the dealer level?

This is the conundrum currently being faced by the demand side. Does the industry continue to buy, or can most wait until previously purchased material is shipped and in route to their yards? Whether to buy, or not to buy.

As we see the markets, it always comes down to timing. At what point do the transportation issues begin to resolve themselves and get product moving in a timelier manner? We all know that point is ahead of us, we just don’t know when.

The same holds true on the other side of the equation. Daylight savings time is here with the workday getting longer. It’s also mid-March and the weather will be getting warmer. At what point does demand pick up on the builder end? At what point does end user outtake overwhelm an under inventoried market?

Buyers have a critical inventory period in front of them. They need to have adequate inventories to service their customers, but not have too much high-priced inventory on hand as the supply/demand equation moves towards equilibrium. And then the inevitable correction to the downside as supply begins to overwhelm demand. It will happen, mills can’t help themselves as they overproduce at these price levels.

As we see it, it doesn’t matter which way you spell the word, whether or weather, either way you better be prepared to buy for the increased outtake from your yards. It’s decision time.

Fundamentals

Very little has changed over the past week on the fundamental side of the lumber market. The only plus for some buyers has been weakness in SYP 2x4, 2x6, and 2x8. Although prices have weakened in these widths, trucking remains difficult at best. Increased fuel prices, coupled with produce season quickly approaching, will keep delivery times extended. We also expect a resurgence of treater purchasing ahead as pricing drops and contract commitments will need to be covered.

Other producing regions of the US have seen a slowdown in purchasing activity this past week with pricing remaining flat to higher. Although demand has been consistent, product availability has been difficult to come by. Unfortunately, transportation issues persist with both trucks and rail cars.

For those buyers in close proximity to US ports, European imports have provided some additional inventory relief while waiting for late shipping mill direct orders. Often times, a good percentage of these shipments have been pre-sold with little open market cash wood available. This usually results in thin, broken inventories to fill customer needs. Of course, some availability is better than no availability. Unfortunately, most importers at this point don’t have any appreciable inventory arriving until the last week of March or the first week of April.

Last, but not least, is the continuing saga of Canadian mill production. Sawmills are stuck between increased production at these very lucrative price levels, and their inability to get their orders shipped to customers in a timely manner. Several producers have actually ratcheted back production to get a better handle on their shipping issues.

We continue to hear the same refrain on a weekly basis, the current issues faced by the industry are not demand driven but supply driven. Not the inability to produce the needed materials but the inability to get the product to the end users. Until these supply chain issues resolve themselves, pricing will remain elevated and inventory availability disjointed.

Everyone knows how we arrived at the current situation, and everyone knows it will end at some point over the near term. The difficulty facing the industry is the balancing act of having too little inventory to service customer needs now versus owning too much inventory as the market corrects. We are currently at that juncture. Is the industry underbought? We don’t believe so. The market feels like it’s in a pause and digest mode waiting for direction. Is the industry under inventoried? That’s a resounding, yes. Everyone is checking on late shipping orders. Is there a need to continue to buy? Yes. Everyone needs to fill inventory holes. Will pricing regroup and continue higher? Yes. Everyone is currently over cautious and holding back purchases. We anticipate one last push higher in prices as buyers attempt to keep up with increased outtake from their yards over the next 60 days.

Seasonally, transportation issues will resolve themselves with more product shipping from the mills and the distribution network able to catch up with the increase in business and inventory outtake. The supply/demand equation will rebalance. The bigger question is, will you be ready? Do you have a plan, and will you be prepared to make the pivot from higher prices and increased product availability? The fundamentals always change, will you be ready to change with them?

Technicals

Most people, in the industry for a while, have often heard the phrase, “cash is cash and futures is futures”. This past week didn’t seem to apply. As cash activity slowed amid concerns of downside risk, futures trading for the week added to the undermining of buyer confidence in the overall lumber market. Adding to the bearish sentiment was a drop in Open Interest for the week by 67 positions. With the close on Friday, open interest settled just above the 2400 mark at 2418. Not very positive for the week.

Of greater interest for lumber futures was the change in daily trading limits effective with trading beginning March 7th. The daily limit moved to $57.00 while the expanded limit increased to $86.00. We saw both on the week. Although a variety of industry pundits decried the move, and the anticipated drop in trading volumes, in our estimation, the week went rather smoothly. Price discovery is what lumber futures is all about, hence the moniker, futures. And very few times throughout the week was daily trading locked at limit. This is a plus for the market and we believe a positive step by the CME to correct some underlying deficiencies in the contract structure. A big thumbs up here to the CME staff!

The March contract continued to liquidate in an orderly manner into the close on Friday. There will be 31 March contracts remaining open with Monday trading. The contract expires on Tuesday. There were 28 March EFP’s posted last week, and we would expect some of these remaining 31 to be reconciled through the EFP process. Why? Because we believe many of these open contracts were purchased well below current cash prices. We have had this discussion in prior posts. If you’re not using the EFP process, or don’t understand how it works, you need to learn. This goes for both the demand side and the mill supply side. Either way, you’re leaving profit dollars on the table.

That said, let’s turn our attention to the front month May contract. At the close on Friday, the May basis finished the week at a +$240.80. That’s quite the discount to current cash prices and an attractive basis to forward price jobs in late May, June, and into July. Would you rather guess at pricing forward jobs using today’s levels of $1400 and higher, or price off of the July contract at $1159.20? Don’t think too hard, it’s a no-brainer answer. Also take a look at the remainder of the back months. This backwardated price structure, with its declining price curve, gives you various opportunities to forward price future jobs for your customers. Not sure how this works? You need to contact industry participants and learn the process. If you have interest, drop us a line, we can get you in touch with several industry experts.

What’s ahead for futures this week? With March expiration on Tuesday, we’ll get a glimpse of market direction as May becomes the new spot month. We expect cash activity to remain firm to higher due to seasonal influences. That said, we also expect the May contract to narrow that extreme basis to cash over the next 30 days. Is the May contract a value at $1159.20? For now, yes. With futures price appreciation, we also anticipate new life of contract highs in May and most of the back months. As we have mentioned before, keep an eye on these life of contract highs for hedging opportunities, especially in July and September where we witnessed lower cash levels in 2021. Not sure how this works? Once again, ask. Use the contract for what it is intended to be used for, risk management.

Be prepared this week as the March contract expires and May steps up to the price plate. We expect the old lumber adage to correct back to normal this week where trading will once again be viewed through the lense of “cash is cash and futures is futures.” Let the volatility continue.

Dollars and Sense

Conifex Timber. This past week, Conifex Timber released both their Q4 and full year 2021 financials. Similar to other industry reports, Conifex expects a strong 2022 for the lumber markets amid ongoing logistical issues. Lumber production in 2021 was 184.1 million board feet while operating at an annualized rate of 77% of capacity. The company expects to improve their operating rate to 90% in 2022 in conjunction with an increase in volume capacity. Management would also expect a decrease in operating costs associated with the increase in production capacity. Sufficient fiber availability is also positive. Further details can be found on the corporate website.

Mortgages. After 5 consecutive weeks of lower mortgage applications, the MBA reported that mortgage applications were 8.5% higher in the week ending March 4. Applications for purchase were up 8.6% while those for refinance gained the same amount, 8.6%. Volatility in rates, coupled with inflation concerns, were cited as factors for increased participation. Also of note, the average fixed 30-year mortgage rate dropped to 4.09%. This was the first drop in rates over the past 12 weeks. A rather pleasant surprise considering the overwhelmingly negative economic news from this past week.

Inflation. Not so encouraging was the inflation news reported by the US Bureau of Labor Statistics this past Thursday. The annual inflation rate in the US increased to 7.9% in February. This is the highest level reported since January 1982. Unfortunately, this matched industry forecasts and expectations. Aside from energy, inflation worked higher for shelter, food, and new and used vehicles. Excluding the energy and food categories, the CPI was up 6.4%. This was the highest rate in 40 years. Unfortunately, administration officials expect rates to move higher and remain an issue through the end of the year. So much for transitory inflation over Fed expectations.

WWPA. December lumber stats form the WWPA,

North American softwood lumber production in December was 8.8% lower year over year. US production was 7.1% lower while Canadian production dropped 12.2%.
Operating rates were lower in both the US and Canada month over month. US operating rates were marginally lower by 1% to 80%. Canadian rates were 16% lower to 66%. BC flooding was cited as a primary reason for the drop.
North American softwood lumber consumption was 9.1% lower year over year in December. The US showed a 9.6% decline while Canadian consumption was 4.7% lower.
US softwood lumber imports were up 4.5% month over month with imports from Canada down by 13.7%. Non-Canadian imports more than made up for the drop in Canadian imports, increasing 78.5% month over month. European imports were the primary driver behind non-Canadian imports with an increase of 122.6% month over month.
US log exports were 5.3% lower month over month. Of note was a 39.2% drop in exports to China.

For more information and particulars, check out the WWPA website. There is quite a bit more detail for those that like to crunch numbers.

Economic Calendar. There are several important housing reports due out in the week ahead. Wednesday brings us the weekly US mortgage applications and rates news at 7 am. At 10 am, the March NAHB Housing Market Index will be released, and at 2 pm, we’ll get the Fed interest rate decision. Thursday at 8:30 am, we’ll see the February Housing Starts and Permits report released by the US Commerce Department. And Friday at 10 am, the February Existing Home Sales report will be released. It will be interesting to see how much the recent global geopolitical events are impacting the US housing markets.

Anecdotal Thoughts

Demand Destruction. Will overall market uncertainty slow the construction industry? Will higher input costs, increased interest rates, growing inflation, and geopolitical uncertainties weigh on the US housing markets? How about seasonal DYI business and R&R as more people decide to stay put in their existing homes? Lots of variables to watch as we work our way through 2022.

Transportation. We have all experienced Covid related issues over the past 2 years. As restrictions get lifted and life returns to some semblance of normalcy, the industry still faces challenges. In front of everyone today is rising fuel costs for the trucking industry. The greater issue over time is lack of drivers, an ongoing issue before the onset of Covid. This problem will only get worse. You can also add in the variety of cargo needed to get moved and the competition for trucks. Also of interest will be the various traffic lanes and which will be more important than others to move loads. This trucking issue is expected to get worse before it gets better. You would be wise to add an extra 1-2 weeks to your lead times.

Lumber Futures. The past several weeks has brought considerable debate among various Twitter participants and the topic of lumber futures. Who uses them, who doesn’t use them. Why are they important to the industry. How many non-commercial types are using the contract, including managed money and algorithmic traders. We here at B+P would be interested in hearing from our readers and their thoughts on the lumber futures contract. Especially with various changes in the contract under consideration.

Thanks again for joining us this week for our take on the lumber industry. We appreciate your support. Our outlook remains bullish for the lumber markets over the near term. Be prepared and have a plan. Be a leader, not a chaser. Take the time this week to talk with those people in the industry that you trust, review market structure and direction. Be engaged. The last place you want to be in this market is not having enough product for your customers when they need it. The time is now, be proactive!

As usual, should you have questions, comments, or suggestions, we can be reached on the following social media platforms,