Now what?

What now?

It’s time to talk about lumber

Another week in the books and the start of Q4 2021. How time flies. On the other hand, who doesn’t want to see 2021end? After three active weeks in the lumber markets, prices continue to grind higher with extended order file at some mill operations. Pricing I understand, order files into the week of October 25th I don’t understand. Note my comments on forecasting and lead times from last week’s post. More on that later. Time for us to look ahead and prepare for the week ahead.

Fool me once

Now what? I heard that question quite often this past week. I guess the answer to that question is how much business do you anticipate the next three months.

If your business caters to the large national home builders, you might want to moderate your purchasing and reevaluate your inventory needs. Several have released statements indicating their desire to slow new home builds in order to reduce their backlog of unfinished properties. Finally some rational decision making.

Early this year, they required their suppliers to have ample inventories so they could keep building homes regardless of how high lumber pricing skyrocketed. We all know how that worked out for the industry. With Q4 upon us, get with your customers and finish out the year in a more orderly process. Then move onto the strategic planning stage for 2022 with this past year fresh in your minds.

What now?

Lumber prices have bounced off their most recent cyclical lows and are now showing some relative strength. Relative strength? Yes, relative. In most years, the market lows are usually seen in October.

Why? Seasonal demand. Big box consumer business is already tailing off into year end. That money will now be targeted for the upcoming holiday season. Or perhaps just keeping their homes well heated this winter.

As mentioned earlier, home builders need to reduce their backlog of unfinished properties. An especially prudent move ahead of winter weather. Without production curtailments moving forward, increased demand is the only way to sustain current price levels or even push prices higher.

Does anyone out there anticipate a higher demand scenario in their markets? I’m rather skeptical. That said, formulate a strategy that works for you in Q4. Now is not the time to squander away hard earned profits up until now.

Market Appreciation

This ongoing rally in lumber pricing feels more “normal”. Supply and demand through the summer months was more measured. Most buying across the supply chain was more judicious. Pricing finally found a comfort level to build support. From there, the process of rebalancing inventories and in some cases building some inventory.

Once again, Canadian SPF was the catalyst. Lots of reasons for this statement and we all should know why. If not, let us know and we’ll explain in a future post. As Canadian SPF pricing gained traction, all the other markets followed in their normal progression. First, European imports. Why? Because Euro import pricing is formulated from a SPF industry index. And, port inventories are more readily available than mill direct cars and trucks out of Canadian mills. Second, all the species produced in the Pacific Northwest. Reasons? Overlapping markets, some species switching, and price competition. Last, but certainly not least is SYP. Numerous reasons why, but usually because of this pricing progression. As other species appreciate in price, SYP then represents value. As witnessed over the past week plus, market dynamics are taking hold with SYP demand on the rise.

Where do we go from here? Can cash pricing continue to move higher? Of course it can. Is there a level of upside resistance? Yep, there always is. In conversation with trusted associates across the industry, several anticipate a trading range from $400 to $700 moving forward.

Our thoughts? We saw cash trading under $400 in late summer. If we were there then, we can go there again. The upside at $700 is the resistance level seen in lumber futures in July and August. Can we go higher? Yes we can, but given the seasonality and demand side of the equation heading towards year end, we think not. Again, do your research, talk to people who’s opinions you value, and make rational decisions.

What does lumber futures tell us?

The most glaring feature in lumber futures has been the large premium in the November contract relative to the cash markets. With the close on Friday at $625.10, basis in November was -$92.10.

This is the rub we have with extended mill order files to the week of October 25th. The next week is November 1st. In reality, at this point, the November contract becomes a sawmill with a two week order file. Mills are “hoping” to sell at $533 and higher as they extend the mills order files to the week of October 25th. Fundamentally, the correct strategy here would be for the mills to sell that production into the November contract and capture that additional $92.10 profit. The more important question here is why aren’t the mills taking advantage of this selling opportunity?

Several mills will take advantage of this basis to attractive EFP business, or should prices work lower toward convergence, just bank the short covering profit in the trade. Others just ignore this basic risk management tool. On the other side are basis traders that will profit from this basis to build inventory at very attractive prices. If you’re in the lumber business, you should have a working knowledge of these arbitrage strategies to manage your inventory risk.

Let’s move to the technical side of futures. Overall open interest remains abysmal at 1787 positions. In fact, Friday’s trading saw November lose 30 positions. Not encouraging. The $625.10 close puts November above the 50 day Ex. moving average of $614. From a managed money point of view, encouraging. Upside resistance levels run from the upper Bollinger Band at $651.40 to the 100 day Ex. moving average at $673.20 to the double swing high resistance levels just short of $700. Without more build in open interest, November has a tough row to hoe to get to $700. Slow stochastics and the Relative Strength indicator aren’t adding much support while trending just above neutral.

Take the time to understand how lumber futures work and how they impact the cash markets. The more information you know and understand, the better decisions you can make in your everyday business. As we have said before, knowledge is power!

Dollars and Sense

This past week, the Mortgage Bankers Association report saw mortgage applications decline by 1.1%. In addition, the average fixed rate 30-year mortgage rated increased to 3.10% from 3.03%. Higher Treasury yields were attributed to the rise in rates. This may not be a transitory event. Home price appreciation is also weighing on home applications as more buyers get priced out of mortgages.

Good news on the surface, pending home sales were up over 8% in August. On the flip side, contract signings were 8.3% lower than the prior year. Not very positive considering the state of the economy last year.

And for those of you watching the stock markets this past week, volatility in the equity markets spilled over into the commodity markets weighing on lumber futures for the week. Transitory inflationary trends are adding to market uncertainty and indecision. Anticipate increased volatility ahead and the impact it will have on the housing markets. This should be part of your overall purchasing strategy moving forward.

Anecdotal Thoughts

This past week saw two buying shows, the True Value Reunion in Chicago, and the Do it Best Market in Indianapolis. Impact on the lumber markets? Uncertain at this point but should be able to gather more information this week. Will keep you posted.

Keep an eye on market production dynamics. According to West Fraser, their overall Canadian lumber production sits at 3.5 billion board feet per year. Their US SYP production at 3.2 billion board feet per year. Have a guess as to how soon those numbers will flip flop? It will happen, sooner rather than later. Be prepared.

On the mill side, GP is investing $120 million in production upgrades at their Pineland sawmill in Texas. Production is anticipated to increase to 400+ million board feet per year. And in Canada, it appears Forex is looking to restart the former Weyerhaeuser OSB mill in Wawa, Ontario in late 2022. Production capacity approximately 500 mmsf per year.

Good news on the revenue front for sawmills, global pulp and paper prices continue to push higher. Demand for sawmill chips is anticipated to increase accordingly.

That’s it for this week, thanks for joining in and sharing. We’re here to listen to your comments, answer your questions, and welcome your suggestions. Please note the buttons below and we’ll catch up next Sunday.