Tuesday, February 16, 2010

Lumber Supply Shock, Nothing Else, Drive Prices Up

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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