HANDLE WITH CARE: EXPLORING LUMBER COST POTENTIAL AS WE ENTER Q4
September 18, 2020Lately, I’ve had songs from legendary rock supergroup The Traveling Wilburys at the top of my playlist. Why do I mention this? Because five months into the most significant lumber market rally of all time, several of the band’s greatest hits are starting to take on new meaning for me. Thus, it felt like a harmonious fit to use a few lyrics from these iconic songs (bolded below) to shed some light on 2020’s lumber market conditions and challenges.
As buyers and traders are beat up and battered around from the relentless pursuit of wood fiber – some in our industry are beginning to wonder if the market may be standing on shaky ground heading into Q4.
Roughly three weeks ago, the CME Lumber Futures contract began its bi-polar trading pattern. At that time, cash market participants recognized September as value-to-cash market offerings from mills, so the September contract held some semblance of strength. Compare this to the November and January contracts, which had relentlessly been sent up and been shot down every day, oscillating from limit down to limit up.
The recent volatility has been unprecedented. The November contract has lost roughly 20% of its value since the week of August 24, all while mill order files remain extended, and many end-users are still clamoring for any available wood fiber.
This begs the billion-dollar question: Is what we’re experiencing an anomaly, or are these market conditions indicative of our new reality going forward? No matter what the answer ends up being, the market's current state is an inflection point and requires extra scrutiny by those buying wood fiber to supply what seems to be an insatiable demand in new home construction.
Alas, it is too soon to determine if this is the beginning of the end for the recent overwhelming market. And while we don’t know whether we are entering the final round of this metaphorical boxing match, or whether there are multiple rounds left to go, what we can do is pause and assess some of what we do know in preparation. Below are a few considerations to keep in mind:
- While it varies significantly by wood fiber species and region, certain mill order files have shortened over the last few weeks. While most order files remain extended, various items that were nearly impossible to procure eight weeks ago are at least showing up as options that producers are willing to quote for future production.
- One of the largest contributing factors to this supply shortage is the overwhelming demand from the DIY segment at North American retailers. Reports indicate that box store fiber consumption continues to trend significantly over 2019. And while many are now predicting the holiday merchandising shift (which typically occurs in early Q4) as the eventual slowdown in this segment's demand, some producers are already forecasting that 2021 box store demand will resemble 2020. Their insight is based on the continued presence of COVID-19, a lessening of consumer debt and a surge in homeowners' discretionary income – all factors that will continue to play a role for the foreseeable future.
- Specific to the CME November and March contracts, the published Commitment of Traders Report points out that, unlike when the market collapsed in February and March at the hands of the Funds Asset Class, this current selling pressure is being driven by the Commercial Asset Class. Put another way, when the market tanked in Q1 2020, it was largely due to outside the industry asset classes, as all financial markets were in a mass sell-off phase. Conversely, recent selling pressure has been driven by those in our industry, as the Commercial Asset Class represents a mix of producers and end-users. This selling pressure is indicative of either producer building a deferred order file, end-users betting on a seasonal correction, or a combination of the two.
As stated earlier, this inflection point is a tough one for those still clawing for wood fiber, as being out of stock and unable to service home builder demand is not an option; however, potentially owning wood that is costed at $120,000 per railcar, but only valued at $70,000, is a terrifying proposition. Again, it is too soon to tell, but if industry publications begin reporting the Futures board activity as cash market despite order files, then it’s the end of the line for this portion of bull market.
In closing, while there is currently significant noise around market direction, markets will trade based on the yet to be determined end-user demand in Q4 and Q1 2021 (based on both new home construction and repair / remodel). Love or hate the lumber market of 2020, those who are successfully navigating these choppy waters are doing so by displaying a combination of wit, cool and credibility; so much so, I believe that Dylan and Petty would deem any one of these buying and trading rock stars worthy of being "a Wilbury." Oh, the sweet smell of success.