Lumber

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Tuesday, February 16, 2010

Lumber Supply Shock, Nothing Else, Drive Prices Up

http://assetprime.blogspot.com/2010/02/lumber-supply-shock-nothing-else-drive.html

Today's Wall Street Journal ran a great article on the recent surge in Lumber prices. (Though, sadly, the online version's headline was changed from the print's pun-tastic "Builders Nailed by Lumber Prices" to the infinitely more boring "High Lumber Prices Threaten Housing Market".) The article does a fantastic job explaining the why's behind the recent insane price movements in the lumber market, which I have discussed at length in a previous post. In that post I laid out my then somewhat limited understanding of the reasons for lumber's price increase, which the WSJ article largely confirms and significantly expands upon. Basically, here's what happened:

• Due to a dramatic falloff in demand, largely the result of a depressed housing market, lumber mills and loggers have significantly decreased production. According to the WSJ article, lumber output fell 45% (!!!) between 2005 and 2009.
• As the housing market remained stagnant, lumber wholesalers saw no need to maintain large inventories throughout 2009, further disincentivizing output from loggers and mills.
• Because of the lack of demand and low prices, several lumber mills have indefinitely shuttered. This, of course, in itself drove prices higher. The article specifically mentions Canfor Corporation, a Vancouver-based producer responsible for half a percent of total North American lumber output, who indefinitely ceased operation on January 5th 2010 as one of the major mills to shut down amid the sluggish market.
• Annually, home builders restock their lumber supplies in January and February in anticipation of the upcoming spring building season. As supply was already incredibly tight and production was being scaled back across the board, wholesale buying triggered a supply shock up the chain, sending prices higher.
• Additionally, some firms continued buying on anticipation of consumers taking advantage of the federal home-buying tax credit before it expires.
• As the industry was not in any place to suddenly ramp up production, the market created something of a feedback loop, driving prices higher from January through to today.
• Exacerbating the problem is that shuttered/suspended mills do not have the capital (or guarantee of near-term capital) to quickly start up operations again.

What is perhaps most interesting about this is that everyone seems to be in agreement that the surge is entirely supply driven. To the question of demand, the article says the following:

"The supply crunch is striking because, just a few years ago, the North American lumber industry was able to supply enough wood to start more than two million homes a year. That was nearly four times the pace of home starts in December."

In other words, home-building demand hasn't simply petered out, it's fallen off 75%, and still, the price goes up purely as supply stays tight. But perhaps the most interesting quote, in my mind anyway, comes towards the end of the article, in a discussion of near-term production prospects:

"The ongoing recession will keep production light, said Matt Layman... who called this the only sustained supply-driven rally he has seen in 30 years of trading lumber."

Thirty years is a long time, and Mr. Layman's quote only serves to highlight just how strange this market rally seems on the surface. My readers already know that I'm bearish on Lumber, but honestly, everything about this rally seems crazy to me. At least now we understand the circumstances that pushed prices high in the first place, but for this kind of rally to be sustained... I'm just not sure what it would take short of a spectacular resurgence in the housing industry.

Tomorrow, the US Census Bureau will announce the figures for January housing starts. A slight bump will be good news for the lumber bulls, a downtick could mean the beginning of the rally's end. I'll put a post up as soon as we see what happens, and what it's immediate effect may be.

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asr: look at his buttet pointed analyiss , this should be standard for our Research Analysis ..

Monday, February 8, 2010

Why I am Bearish on Lumber

http://assetprime.blogspot.com/2010/02/why-i-am-bearish-on-lumber.html

By bearish, of course, I mean pessimistic. In other words, I expect the price to go down.

Here's a chart of Lumber futures prices over the last month:

View the full FUTURE:LB00 chart at Wikinvest

Of particular interest is the big upward movement starting on January 28th. Between then and this last Friday, lumber TWICE went up the session limit of $10 / thousand board feet (mBF). At the beginning of the month, I was bearish on Lumber because I suspected housing starts have not actually increased whatsoever (and at the time I took a short position, only to be stopped out in accordance with my personal trading philosophy), however, now I am even more bearish because I don't think this pricing run up either makes sense or is in any way sustainable.

Quick background about the market, the random length lumber futures contract (what most people mean when they say "lumber") is used extensively by lumber industry participants, that is timber harvesters and construction companies, to hedge against erratic price movements in the cash market (the price you get at your local mill on any given day). The biggest factor affecting lumber prices is the US housing market. When the housing market is booming, lumber skyrockets. When home construction is depressed, so too the lumber market. There is very little else driving lumber prices, as most of the lumber we use is grown domestically, we export almost none of it, and what lumber we do import comes almost exclusively from Canada.

Now that that's out of the way... a recent article from Reuters basically comes to the following conclusions as to why the price has shot up:

1. There are fewer mills currently in operation (many had closed down when the housing market dried up), creating a minor supply shock in the cash market and sending prices up.
2. There is an expected increase in demand as the result of the approaching "Spring building season".
3. A "realtor survey" showed pending home sales were up 1% in December.

My reason for being bearish on Lumber right now is that I believe there is a logical fallacy at play in the market. Follow me here on this treatise:

• If the housing market picks up (i.e. demand increases)
• Lumber inventories (i.e. supply) should be pressured and may diminish.
• If inventories stay the same or diminish
• The price should go up.

This is basic supply and demand, but I've made each bullet cascading to point out the conditional nature of how the market, in theory, responds. The other way for the price to go up would be as follows:

• If lumber inventories diminish (i.e. supply decreases)
• If the housing market moves sideways or picks up (i.e. demand stays the same or increases)
• The price should go up.

Note the difference between the two cases. In the first, demand is the driving conditional; in the second, supply. Also note, and this is what's important, that demand, and demand alone, has an effect on the other predictive variable in the equation. That is to say, when demand changes, there is NECESSARILY an effect upon the supply. (Yes, I know, it's possible that demand has been perfectly predicted and supplies tailored to meet the expected demand, but this is incredibly unlikely in a market based upon a fungible commodity such as Lumber.) When supply decreases, on the other hand, there is by no means any necessary or expected response in demand. Demand could stay the same, demand could increase, demand could decrease. There's simply no way to know, or even extrapolate, based on supply alone.

What we have in the lumber market is the second scenario. Supplies seem to be diminishing because of the drawdown in milling operations. However, that in and of itself, in theory anyway, should not cause the price to go up. For that to happen, we'd need to see that demand has at least not diminished, or at best, has increased. If this were the other way around, if we knew that demand really was increasing, we could infer that supply was likely to decline, and the facts about the mill drawdowns would confirm this, and we could say that yes, indeed, lumber prices ought to go up. However, we cannot say that demand for lumber is increasing, we can only say that supply looks like it might be decreasing, and there is at best a possibility that demand is on the rise, depending on how much faith you put in a self-reported survey from an industry with a financial incentive to make itself look healthy. As for the "spring building season" mentioned in the Reuters article, it's important to note that this is buying by retail lumber dealers in anticipation of the season. This is not a construction company buying lumber to build a house. Unless that lumber is actually used, it will just sit on the shelf, delaying future orders and adding to the supply.

Of course, we can talk about what a market should or shouldn't do in theory, about what's the right or wrongexpected price movement based on any set of information, but the truth is that a market cannot be right or wrong. A market simply is. Lumber is trading at over $270 / mBf because someone was willing to buy a contract at that price, and someone was willing to sell. However, while the market itself cannot be wrong, the participants in the market can be. Extrapolating that supply is decreasing based on mill slow-down is an assumption, and it can be incorrect. Believing the housing market is picking up is an assumption, and it too can be incorrect. If two people, a buyer and a seller, have the same incorrect assumptions, the price they agree on will force the market in a particular direction, and this will happen regardless of the assumptions' validity.

Now, this buyer and this seller, they might be right. It might be the case that lumber supply is falling, and that demand is picking back up, but personally, I don't think so. I don't think the housing market is picking up, and I don't think supplies are in any way close to depleted enough to cause a significant shortage. Housing starts declined in December, you can read the reports on the Random Lengths website (a sort of trade-mag for the lumber industry); do we have any reason beyond the above "realtor survey" to believe they have increased since? Again, maybe. Maybe I'm wrong about this, it's very possible, but I simply don't see housing starts increasing enough to justify this price run up.

Again, I could be wrong. I could be dead wrong and the US housing market might be ready to explode and the decline in mill output might cause a serious supply shock, but even so, in closing, let me drop a little perspective. The last time lumber was consistently trading above $260 / mBF was May - August 2007. Between then and now, it broke the $260 barrier only one other time: August 2008.

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Why You Should Buy a Lumber Futures Contract

http://www.wikinvest.com/wikinvest/api.php?action=viewNews&aid=104842&page=Futures:Lumber_Futures&wire=1&format=html&comments=0

Posted on: Mar 12th, 2008 | By Tom Dyson | Filed under Gold Market

If you laid all of the 2×4s that make up a railcar full of lumber end to end, they would stretch 32 miles.

I know this oddball fact because I want a railcar full of lumber.

You see, I’m planning to buy a lumber futures contract. The standard contract of lumber on the Chicago Mercantile Exchange is 110,000 board feet. This is the capacity of a standard lumber centerbeam railcar. (I traveled on top of a lumber car once… out of the BNSF Spokane yard… but that’s a story for another day.)

I’d love to have this wood in my front yard. But I don’t have a warehouse, and I don’t have a railroad spur to my door. That’s what’s great about the futures market. I can buy lumber now ( 3/2008) for delivery in the future.
A railcar of lumber sells for $20,000. A November (11/2008) delivery of lumber, however, costs about $27,000 today. I’m okay with the extra cost (the $7,000 over the current spot price). Lumber spoils. Storage is expensive. I’ll pay the premium for a future delivery.

And in fact, I won’t take delivery of my lumber. What would I do with 32 miles of lumber, anyway? I’ll sell it to someone else before the delivery date in November.

I want to buy this lumber because, in my opinion, it’s too cheap. As a long-time lumber broker and trader told me on the phone just now, prices are “economically unsustainable.”

Let me explain:

Even the largest, most efficient producers of lumber in North America cannot fill a railcar full of 2×4s for $20,000.

Take Canfor for example. Canfor is the largest producer of lumber in Canada. It made a profit in 2006 and a loss in 2007.

	Railcars Shipped	Average Price of Lumber per Railcar	Profit or Loss
2006	40,500	$32,450	$471 million
2007	38,000	$27,500	-$360 million

These numbers are very rough, buy they imply that for Canfor to break even, the company needs to sell a railcar of lumber for around $30,000. It’s nowhere near that now.

With the market price for a railcar of lumber at $20,000, (price on 3/2008) every lumber producer in Canada is slowly going bankrupt, including Canfor. The Vancouver Sun did a survey. It found the Canadian logging industry shut down 34 lumber mills and fired 10,000 workers in 2007.

asr: on 3/3008 historical contract price shows range of 190 to 230 , see below link
http://www.pfgbest.com/traders_tools/quotes/ib/?page=chart&sym=LSK0&studies=VOLI;&a=M

Lumber is down in part because the housing industry is in a slump – homebuilding and remodeling make up two-thirds of U.S. lumber consumption. Right now, the major Canadian producers are trying to raise cash and ward off bankruptcy, so they’re dumping their inventories on the market. That’s pushed lumber prices even lower. But soon, there’s going to be a shortage of lumber.

Contractors will notice how cheap lumber is and will decide to start building houses again. But they’ll find the forest industry has shuttered all the mills, fired all their workers, and sold all their lumber.

This will cause lumber prices to rise. I expect they will double within two years… to around $40,000 a railroad car. I plan to buy my lumber with 50% borrowed money, so I’ll double my money if I’m right. The risk is if prices stay low longer than I expect, I lose $7,000 in storage costs.

If you want to play this idea without using futures, consider buying stock in one of the large Canadian forest-products companies like Canfor (Toronto: CFP) or Western Forest products (Toronto: WEF). But there’s risk here, too. These companies have enormous debts and are at a high risk of bankruptcy…

So what’s holding me up right now? As much as I’d like to buy, lumber is still in a downtrend. I’m waiting for the price to turn around and prove my thesis. So before I buy my railcar of lumber, I’ll wait for a 10% rally in lumber prices.

More to come when I see that rally…