Lumber Market Report – 4th Quarter 2019
Lumber being loaded for another project at our Clinton, SC facility.
I’m not sure if you could have two more divergent paths when comparing the 2018 lumber market with what has transpired so far in 2019. The record setting volatility of last year has been replaced by relative calm in comparison – a pace and trading level much more traditional, and acceptable to builders and lumber concerns alike. Last year was a tumultuous year, when supply-side shocks sent lumber prices into orbit the first half of the year, easily setting record highs and handcuffing the supply chain every way imaginable. The correction in the second half of the year was just as eventful, as the run-up reversed itself and created an atmosphere of frustration that I have not seen in my 36 years in the industry. The only thing even close was the “spotted owl” calamity of 1993 when the government, for all intents and purposes, shut down the forests to timber harvesting, and drove lumber prices to record levels that only this latest calamity could eclipse. In this report, we will take a brief peek back at what happened last year, take a little more detailed look into what has transpired in 2019, and finish with a glimpse of what twenty-twenty may have in store for us in the lumber and building industry.
2018 - A Year to Forget.
Supply-side dysfunction would be the best way to describe the first half of 2018 – followed by a substantial correction. Housing demand, which had been steadily growing year-over-year since the recession, posted an exceeding high number of new home starts in the first five months of the year. U.S. housing starts increased to 1.32 million seasonally adjusted annual rate (SAAR) through May, a level we had not achieved since before the collapse of the housing market started in 2006. In hindsight, I think that early activity probably spurred a level of lumber buying that helped kick-start the market’s run. When producers couldn’t keep pace, the train jumped the track. Well, not exactly, but it was major rail traffic and over-the-road trucking disruptions, that essentially sent the market soaring. Lumber buyers were in a panic, unable to get timely shipments of wood they had sold. Projects were being delayed because suppliers didn’t have the lumber. It was like we were fighting over the last damn 2 x 4. It was an unprecedented situation and the result delivered record prices for lumber.
From January to June, Contract Lumber’s Commodity Lumber Price Index (CLPI) gained $155, over 40%. On June 1st, the CLPI reading was the highest level ever recorded – $538, 13% above the previous index high set back in 2005. The Random Lengths Framing Composite also hit its highest level ever on that date, besting the 1993 high. Of course, everyone knew the market would eventually change directions, as commodity markets always do. But the severity with which the air came out of the balloon surprised us all. Over the next 17 weeks, the market gave back much of the gains from the first 22 weeks of the year. Housing demand sagged quickly as both starts for single family and multi-residential housing underperformed. Affordability challenges and uncooperative weather had significant negative impacts on home building activity in the second half of the year. Higher mortgage interest rates were also dampening demand as rates were approaching 5.0%. The market eventually bottomed near the $300 level at the end of the year, around the same level it was before the Countervailing Duty and Anti-Dumping tariff announcements jolted the market higher in early 2017. Everyone was happy to turn the page on the calendar to 2019.
2019 – A Calmer, More Traditional Market
After two turbulent years in the lumber market that saw prices surge over 68%, we were all due some relief, and luckily, 2019 delivered. Prices had finally returned to levels more reminiscent of the previous four years, 2013-2016. One just has to look at the averages of our CLPI to get a clearer picture. In 2016 our index had a swing from high-to-low of $84 (31%). Volatility ratcheted up in 2017 with a swing of $119 (37%). In 2018, the market put a whole new meaning to volatility with a high-to-low fluctuation of $245 (84%). And while 2019 started in similar form to the past two, with prices escalating quickly in the first six weeks, things calmed down quickly and lumber grinded lower through May. The high-to-low swing so far in 2019 has been $78 (29%). Finally, some stability.
Housing demand was stifled in the first half of this year, with starts down about 5% from the same period last year. Many blame an extended winter and wet spring for a slow start to the building season. Fortunately, the pace of starts did rebound in the 3rd quarter. In fact, August’s housing starts were the highest monthly level recorded since August 2007 – posting 1,386,000 (SAAR) units. Activity fell back a bit in September on weak multi-family performance, but the most recent October starts data was back over 1.3 million. Mortgage interest rates have been on a favorable downward trend most of this year, almost a full point and a half basis points lower than this time last year. This trend has helped offset continued home price appreciation that has posted year-over-year growth for 91 consecutive months, and still remains a major challenge to housing affordability.
With lumber prices said to be hovering around variable costs for producers in late 2018, many decided to deploy a strategy of production curtailments and mill closures to bring about more balance to lumber’s supply-demand relationship. With billions of square feet of lumber capacity now off the market, the tactic appears to have halted the retreat in prices, but has failed to give any real meaningful lift. We have seen some minor escalation in pricing since mid-June, and the market seems to have found some traction in the past month, but given the time of year, any significant run seems unlikely.
Ironically, the escalation of the U.S. trade war with China has had an impact on lumber prices. The southern yellow pine market in the Southeast has taken deep hits as exports to China from SYP producers have dropped off dramatically this year. The result has increased the amount of pine being absorbed into the domestic market, helping to suppress pricing. This situation is not expected to be remedied quickly as Canada has replaced the U.S. as the key exporter of wood into the active Chinese market.
Generally, 2019 has been void of the supply-side dysfunction that overwhelmed the market last year. The transportation bottlenecks, weather, and wildfire impacts, have been fairly minor. This means wood has been available in a timely manner, and at a pricing level that seems like a value when compared to the previous two years. That negates the need for lumber buyers to sit on expensive stockpiles of wood, and allows them to revert back to more just-in-time inventory management strategy that most are more comfortable with. This also helps keep a lid on volatility.
2020 – A Sneak Peek
Shelter needs overall remain high moving into the new decade, as demographics are favorable. Over the next ten years, the population of first-time home buyers is expected to be about 3.1 million people larger than it is today, according to the real estate database company, Zillow. New household formations, the key driver of housing demand, has been climbing since the 3rd quarter of 2015, while the number of renter households has been on the decline nationally. According to Census Bureau data, the U.S. homeowner rate has increased to 64.8% in the 3rd quarter of 2019. The rate reached a modern day low of 62.9% in the 2nd quarter of 2016, compared to the peak of 69.2% in 2004.
We are in the midst of the longest period of economic expansion ever recorded. The stock market remains strong, we have a relatively low inflation rate, wage growth is on the upswing, and buyer and builder confidence remain high. The Bureau of Labor Statistics (BLS) reported a decline of 0.2 percentage points in the unemployment rate, to 3.5% in September. This is the lowest level of unemployment in the U.S. in 50 years.
But while the current economic environment remains positive, many analyst project economic growth will decelerate over the next year, as impacts from the trade war flow through the business investment and manufacturing channels of the economy. However, the housing sector is expected to show resiliency, thanks to pent up demand, and an anticipated lower interest rate environment in 2020.
Housing affordability continues to be the critical issue throughout the construction industry. Constrained home supply, persistent demand, very low unemployment, and steady economic growth, all work in favor for continued escalation of U.S. home prices and rents. The Bureau of Labor Statistics (BLS) reported rents increased 3.4% annual rate in September, the largest jump in two years. And, according to the National Association of Realtors (NAR), the median home price gained 5.9% in a year-over-year comparison. New home sale prices have edged down this year partly due to a decline in the size of new homes being built. So far this year the average square footage has dropped by 3%, a trend expected to continue, as more entry-level homes enter the market.
Housing forecasts for 2020 range from flat, to slightly elevated, depending on the source. Scarcity of available lots and tight labor markets make it difficult for builders to significantly increase construction, while strict zoning requirements continue to make it difficult to develop high-density projects. Given these limitations, seeing a breakout housing market in 2020 seems unlikely. NAHB analysts expect a slight uptick in single-family starts (902,000) and limited growth in multi-family (384,000) for a total housing start forecast of 1,286,000 next year. The caveat will be favorable mortgage interest rates. The market has become very sensitive to rate hikes so if we can keep rates at, or below the 4.0% range for a 30-year fixed rate mortgage, expect a solid showing in the single family housing market in 2020.
Lumber Market – expectations
U.S. lumber demand in 2020 is projected to be similar to housing expectations – relatively steady, with the possibility of slight adjustments up or down, depending on the impact of declining home sizes. Lumber consumption has grown at a 5% clip year-over-year since the beginning of the housing recovery in 2011. It has been the supply-side gyrations and outside influences (weather, wildfires, hurricanes, flooding, trade tariffs) that have led to the recent volatility. Early on during the recovery, it was lumber producers that struggled to meet the uptick in demand due the downsizing of the wood producing infrastructure during the recession. This drove wood prices higher. But as capacity increased, creating more balance between supply and demand, wood prices stabilized from mid-2013 through 2016. Then the U.S. imposed 20.23% tariffs on Canadian lumber in early 2017. It took a market that traded within a 25-dollar range either way of $275 the previous year, to a CLPI that averaged $310 in ’16, $390 in ’17, and a whopping $420 in 2018. While it was difficult enough to see prices escalating, it was the severity of the weekly jumps that caught everyone off-guard. In 2018, 22 weeks reported double-digit increases or decreases – something unprecedented in the lumber market.
The soft market since late 2018 has led to some manipulatory-tactics from the wood products sector, as they attempt to align supply with demand in a bid to prop up lumber prices. Expect more announced sawmill shutdowns and curtailments moving into 2020, both on the lumber, and the panel side. The debate is whether that maneuvering will be able to offset level demand and recent oversupply.
North American lumber capacity is expected to be level over the next few years. Wood fiber constraints and elevated log costs in the Pacific Northwest and western Canada will essentially cancel out rapid expansion of new production slated to come online in the U.S. south. I would expect more volatility in the western spruce market than in southern pine prices moving forward, and this could push buyers to switch species.
Another consideration is that mills are bigger, and ownership more concentrated in today’s global marketplace, which is true of just about every industry. Canadian ownership of mills in the U.S. has grown at a staggering pace just in the past five years. Today, three of the five largest producers of southern lumber are headquartered in Vancouver, BC. It seems to me that the current environment makes it easier than it’s ever been to make production cutback decisions, especially regarding older, less production-efficient sawmills. That will be particularly interesting in the OSB market, where ownership is extremely concentrated, and newer, high-capacity mills have opened operations in the past year. So far, supply response from the OSB market has been much more measured than their lumber counterparts regarding capacity reductions. I am guessing OSB producers are not thrilled with the current pricing levels of OSB, so I do anticipate additional announcements soon about 2020 panel capacity realignment.
In conclusion, 2020 is shaping up to be a very interesting year. It seems analysts are playing down the potential for even moderate growth in housing, and they expect lumber prices to remain stable as well, trading within a relatedly narrow range. Almost mundane, if you will. While that wouldn’t be the worst thing that could happen, it has been my experience that there are always various change factors at work that can lead, either directly, or indirectly, to unpredictable swings in lumber supply, demand and/or prices. I don’t recall any analyst predicting what happened in 2018. Stay tuned…reality is just around the corner.