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Wednesday, March 14, 2012

U.S. Lumber Prices Drifting Upward on Supply Shortages

Reuters headline from today:

"Credit crunch an unusual ally in U.S. lumber rally"

U.S. lumber futures prices have soared about 30 percent in the past five months, with bets rising 18 percent since January with help from an odd ally - a credit crunch in the industry.

Lumber distributors -- who channel supplies from mills to end users -- finding it difficult to raise loans to buy lumber in the cash markets are resorting to buying futures as a hedge and to possibly take delivery when a contract expires.

Lumber supplies available to distributors in the cash market have also been shrinking due to a pick up in the housing market in the wake of a mild winter in the country.

"Distributors are having trouble buying lumber in the tight stocks environment and also they can't get capital from banks so they're buying futures," said Brian Leonard, a futures broker and analyst for Leonard Commodities Inc in Chicago.

Open interest in lumber futures is up 18 percent and spot lumber prices are up 12 percent since January, indicating new buyers in the futures market.

The rest of the article goes on to explain the phenomenon we've been seeing since last year...lumber supplies are slowly tightening as mills shut down or cut back on production one by one, and yet lumber brokers and builders are finding credit hard to come by as the warmer than usual late winter has allowed the building industry to warm up a little earlier than usual. Result: a slight upward price pressure on lumber thus far this year, even as the slowdown in the Chinese economy reduces their lumber imports.

I forecast this slight buoyancy in the lumber markets in a January presentation to the Western Pallet Association, and thus far my forecast is right on track.



In the presentation, I described this baseline scenario as a flat lumber market with a little buoyancy provided mainly by upward pressure on oil prices. My modeling logic is that lumber producers are selling lumber into the market near cost, and that oil price fluctuations have pretty much become the main driver of lumber prices in a market of minimal demand. So, under a "baseline scenario" that precludes any shock to the global economic system, lumber prices (as represented by the Random Lengths structural lumber composite) will remain pretty flat, bouncing up against $300/mbf a couple of times this year, but restrained by housing starts data that will continue to disappoint.

However, I've also forecast a "spike series scenario" that attempts to account for any of a number of potential global price shocks to oil and the global economic slowdown that would follow. This forecast is shown below. To use this forecast, you would need to follow the baseline series prices above until the price shock hits, and then use the series below from there on.


Here we see that the spike in oil, which could drive oil prices to over $200/barrel according to even the most conservative of estimates, should drive the structural lumber composite up to around $350 or higher for a very short burst, but then the price will collapse as business spending (and building) crashes to a halt. Under this scenario, lumber will fall to prices that will in real terms represent historical lows.

Let's hope that doesn't happen, for many reasons.

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