Lumber prices poised to increase, but climb may be short-lived

By Paul Jannke RISI

f UMBER prices typically see subI-Jstantial movem€nt in the first quarter. Unfortunately, the only movement we've seen this year has been down. Are we near a bottom? We think the answer is yes.

Lumber prices are well below our estimates of variable costs, as evidenced by the spate of closures and downtime that have been announced in recent months. Moreover, dealer stocks are now being measured in weeks, not months. Finally, lumber consumption has begun to increase seasonally as the spring building season gets underway.

So, lumber will become less available as mills cut production. At the same time, end-use consumption will rise (seasonally) while dealers lack the stocks on hand to supply the increased demand. This will be the impetus for a rally in lumber prices over the next several months.

While we expect prices to move higher, the upside potential will be limited by several factors, the foremost being cyclically falling end-use consumption. Housing starts averaged just over 500,000 units (SAAR) in January-February. Meanwhile, construction on existing properties has fallen sharply in early 2009 as well.

The weak residential construction markets were likely influenced by unseasonably bad weather in the Midwest and Northeast (the regions that saw some of the greatest decline over this period). Nonetheless, high new and existing home inventories, tight credit markets, a collapse in cash out refinancing, and the worst recession in generations will all keep downward pressure on construction for the next several quarters.

Finally, industrial production has plunged. The manufacturing sector is likely to remain under pressure through mid-year as aggregate demand remains weak and companies continue to draw down inventories. Another factor limiting the upside for lumber prices are the very market forces that those higher prices will elicit: production will come back online as mills stop losing money and in some cases begin to turn a profit. We have seen several billion board feet of capacity curtailments over the past several months because prices were below the cost of production. With prices rising, mills will ramp up production to take advantage of one of the few times during the year where they may actually make some money.

So what is the bottom line? We expect prices will increase 25Vo from their first quarter lows to their peak midway through the third quarter. In addition to being mild, this rally will be short-lived: as the building season winds down toward the end of the year, we expect lumber prices to again move lower. However, they will not retest the first quarter lows as dealers will not have as much inventory to draw down this year as they had in 2008, and so ordering will be steadier.

Moreover, we expect the overall economy, consumer confidence, and housing markets to be improving by the end of the year. This will lead dealers to build more inventory than they did in late 2008iearly 2O09.

- Paul Jannke is senior vp. of wood & timber information for RISI, a leading information provider for the global forest products industry and publisher o/Crow's Market & Price Service, which offers free trial sub scriptions at www.risiinfo.com/ crows. Reach Mr. Jannke at pjannke@ risiinfo.com.