Odd Lots - Lots More With Stinson Dean on Crashing Lumber Prices

Episode Date: July 5, 2024

Lumber prices have tumbled dramatically in recent weeks, with benchmark futures falling about 20% in the past four months alone. What's more, this is happening at the height of the summer homebuilding season, when there should theoretically be lots of demand for construction materials. In this episode of Lots More, we speak to one of our favorite guests about what's going on in the lumber market right now, and what falling prices might say about this important part of the US economy. Stinson Dean is the founder and owner of Deacon Lumber and he talks to us about why prices are crashing, what he's seeing in the market right now, and how the current environment differs from 2020 and 2021, when lumber prices went parabolic and mills couldn't keep up with demand.See omnystudio.com/listener for privacy information.

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Are you guys doing anything interesting for Fourth of July? Nope. It was nice talking to you, go. You know, out in East Hampton, they don't do fireworks on the floor. It's a good thing we're not having a conversational podcast or anything. Tom says you've got to watch the puck when you're on the bench, Tom Keane. And I'm not, is that an insult? What does that mean?

I don't understand hockey. you're not playing, you have to watch the game. Is this about your face cut? I don't know why I use on the bench, but... Yeah, why am I on the bench? Yeah, well, maybe if you're on the ice, you would have been paying closer attention. Yeah, you can't... In hockey, when you're on the bench, you're exposed.

So if you're not paying attention, you could get hit in the face with a puck. Why don't they just build, like, a little protection thing, like in baseball, like a dugout? Because they get on and off the ice by jumping over the wall. Oh. Man, I hate sports. I did a deadlift. One, two, three. Hedgemi.

Okay, go. Barges. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Where's the best with impostin? These are the important questions. Is it robots taking over the world? No, I think that, like, in a couple of years, the AI will do a really good job of making the oddlots podcast.

and people say, I don't really need to listen to Joe and Tracy anymore. We do have... Cha-ching. The perfect guest. Welcome to lots more where we catch up with friends about what's going on right now. Because even when odd lots is over, there's always lots more. And we really do have the perfect guest. So for those who don't follow Tracy on Twitter, which you should all be,

she posted this freaky photo that two in the morning that everyone thought was like Halloween. or like costume makeup because you have this big gash on your face. What's the story there? Someone said the Dow was a better index than the S&P 500. And so I had to fight them. That's me. Yeah, that's right.

You should see the other guy. Everyone look at Joe. No. You know, someone threw a large platinum coin at my head and then ran off and I heard them say something about a trillion dollars. I'm not sure what that was about. Because that's interesting, because I thought it sort of looked like you got hit by a two-by-far.

I thought you got hit by like someone like slammed a big piece of lumber in your face. Actually, you know, I think that's what it was. So unfortunately, I wish I had a dramatic story to tell about how I ended up with this like four inch gash on my forehead. But basically, I was trying to hang a frame while standing on my bed and I fell off the bed. And I'm pretty sure my face hit the frame. So like kind of a two by four. Yeah, sure. It's a cool photo. I think you should make your Twitter profile. Yeah, I might actually. It's actually pretty bad. Thank you. The matches themselves aren't quite as glamorous, but I'm willing to live with them.

But anyway, I'm glad you mentioned two by fours because there are some interesting things going on in the lumber market at the moment. And we really do have the perfect person to talk to Stinson Dean, president and owner of Deacon Lumber Company, who's spoken to him many times before about what happens in lumber. Yeah, the one piece of advice I've gotten in lumber trading is don't try to catch a falling two by four. Classic. Classic. Yes. Yeah, we're in that now and Tracy's living, Pruch. No, you know how I know lumber prices are falling. It's because I just bought like all the lumber that we need for that giant shed. It's because I've finished my acquisition. And so inevitably, prices start coming down. You bought the top. Yeah. It's always the case. Wait, okay, so prices are falling. What's going on? Because, you know, what? lumber, it's not exactly a monolith. There's different types of it, as we've learned a number of times at this point. But like, how bad has the price action been? It's been pretty bad, like lower than I thought we would go. There's this kind of age-old philosophy in lumber trading that we won't trade below the break-even, specifically the break-even of British Columbia two-by-four producers. And Coming out of COVID, there's so much issues getting product that folks switched species to cheaper, more available species from the U.S. South.

And I started to think maybe British Columbia lost what I call it's peg. Like everyone would peg like to the BC break even. Well, we've been well below that. It's kind of a mystery what it actually is. Maybe it's a little bit lower than we all thought. And we've been trading well below it. Now we're trading below even the southern yellow pine. and the cheap species break even.

So we're just way cheaper than anyone thought we could go because, hey, you can't trade below the break even for too long. But here we are, I don't know, six plus months probably trading below that number. So just to be clear, when we talk about the break even price, this is the cost, basically, of the various mills to acquire raw timber and then process it into, you. usable would. Exactly. Cost of the log, the labor, and inflation plays a big part of that. So, you know, break-evens have leg taken a step up since pre-COVID. And I assume, okay, so no one wants to lose money. Have we seen a supply response yet? Have any of the mills been idled or anything like that in response to lower prices? Yeah. So slowly but surely we recall them curtailments. Those curtailments have started to add up.

I think we're over a billion board feet in British Columbia. Again, everyone's looking towards them as that peg. But now we're looking at like, do we need to curtail, which is different than closing. And I think personally, we need to close a lot of like permanently shut mills and British Columbia. And then now there's talk of like, what do we need to do to reduce supply coming out of the southeast, the United States with the Southern Yellow Pines. So there is an accumulative effect happening, but it's not all at once. So it's not really headline grabbing. It's kind of one z-twosies.

This is happening? And then people don't believe it. And is it a curtailment, meaning they're going to turn it back on later if prices respond. Is it a closure? When you close these mills, and you're not opening them back up, but there's a fear when you curtail, whether that's reducing from three shifts the two shifts, something like that, you're going to lose your workforce. And the U.S. South, that's the biggest fear. If you cut shifts, like they're going to go work for Amazon. And there's a lot of investment in the U.S. South. So there's a very tough decision to be made to we curtail and risk losing our workforce that we work so hard to get over the last several years.

It's kind of a race to the bottom at the moment. That's really interesting. It also just seems bad to curtail a bunch of mills and lumber supply at a time when we're still talking about structural undersupply in the housing market. No, this is really interesting because we've talked about labor hoarding in the past. And all these companies, they're anxious about losing workers. And maybe it's the first time for many of these managers and CEOs where they had a hard time working or they had a hard time hiring. But it's interesting dynamic to say, well, maybe there are aspects of that that are disinflationary or deflationary for certain prices. because it implicitly means continuing to run the operation at a loss, contributing to oversupply

of the key commodity because the alternative is that labor loss. I hadn't really thought about that aspect. No. Wait, Stinson, is the market, is it, so normally lumber futures are in contango. So the spot prices are lower than prices further out. Is that still the case? I'm starting to wonder whether or not I should be stockpiling lumber and, you know, just wait a year or two. Yes, yeah, it is. I don't know what the definition of a supercontango is, but I think we're in it or approaching it, meaning the futures market is paying you above and beyond what it actually costs the store for 60 days or 60 days in between each of our contracts. And we have a deep carry. I always like to say the futures, they don't have to be right until you get into expiration, which is where we're in July 2nd. our July contract expires July 15th. Typically, all the speculators and outside money is long gone before the spot month comes into the calendar month.

And we're seeing the spread, the July losing tremendous amount of value relative to the next month in September. So yeah, huge carries in the market. The market is begging participants to store lumber. Don't put it on the market. Don't put it up for sale. the market will pay you above and beyond your interest, insurance, and storage costs to keep it until September 15th. And at this pace, January will probably pay you to not sell it until January 15th. And we'll kind of go from there.

You have storage, right? So you're a lumber trader, but you're not just like one of these guys who looks at his computer screen all day. You actually have capacity, right? Yeah, yeah. That's one of the things we invested in coming out. out of kind of the windfall of COVID volatility is storage, indoor storage specifically. You have to be able to keep lumber out of the weather and dry. And so we invested in a lot of storage options for us so we can take advantage of these

carries in the market. And yeah, my day job is buying physical rail cars of lumber, shipping it right now, shipping it into the storage facilities and putting a hedge on it and then going fishing, waiting for the market to come back to us. The stints in lumber reserve is what basically is. Strategic stints and lumber reserve. I like that. SSLR.

So you touched on the unemployment aspect just then. But of course, when people think about lumber prices, I think the first thing they think is that this is a traditional arbiter of economic activity. So if lumber prices are going down, it's probably because people aren't building that much. And that suggests that something bad is happening to economic. growth or at the very least it's starting to slow. Is that the basic read-through here? I think so. I think you look at lumber was kind of the first thing to hit headlines and set new all-time highs back in 2020 and then really became a popular thing to talk about in 2021.

At the time, I'm like, hey, this is fundamental. And we got COVID supply chain shutdowns and they can't get their workforce back. And, you know, if you get test positive, you got to sit down. is stay away from work and we couldn't get caught up. All that's fixed. And so we're at very, have very efficient supply lines now. And at the same time, we're looking at housing starts, really showing what the lumber industry has seen since January, which is really weak demand. As a lumber trader, I would say lumber supply chain is too fixed.

Like, it is very smooth. Rail cars are getting from British Columbia to Atlanta on record. time, record speeds, and lumber is getting produced as much as you could ever want. Everyone has it. There's no fear of a shortage. The end user lumber yard is able to run kind of a lean just in time inventory model again. And it's so the supply chain side is very fixed. But then now we have kind of a broken housing starts world where, you know, the number one

demand a lumber is repair and remodel and just behind that a single family and then way down the list is multifamily multifamily is less than 10% of of lumber demand wait sorry what's first again single family or repair oh okay okay this is interesting repair and renovation yes repair and remodel this is important yes so on that note is it possible that like in the post the immediate post 2020 period. We just had everyone remodeling their homes. And so, you know, that sort of took care of demand further out. Or that maybe because lumber prices went up so much, you have this huge supply response from the mills. And so there's just oversupply. Like, is it possible that this is something that's still very pandemic specific versus something that's about slowing growth?

Well, Tracy, it's a good way to frame it. Because I'm thinking, you know, My initial thought is like, oh, this is an economic indicator of slowing growth. But also, I want to say we clearly now, I think undisputed can say we had pull forward demand of repair and remodel. So projects that would have been spread out over five years got crunched into 24 months. And now we're on the back half of that five years and there's not much business to kind of float and handle the supply that we have. So I don't know. Is that the definition of slowing economic growth is pull forward? I don't know, that's over my pay grade, but I think it's clearly what happened is there was a repair and remodel boom that has really, and one of your housing and lumber guests, Dustin Jalbert has tweeted about it.

Repair and remodels kind of flat to down and dead in the water. That's a lot of big box, Home Depot, Lowe's, Menards business. And that's 50% of lumber that's produced goes to that sector. And it's down. And then we all know. those single families down just in time her supply to be as efficient as it's ever been. And lastly, I haven't been able to mention pre-COVID, 1819. There's a ton of CAP-X to invest in the U.S. South. Sorry, 1819 or 19, wait, 1819? Oh, sorry. Sorry, I read that.

Pre-COVID in the year 1819. 1819. Which is technically pre-COVID. Oh, yeah. That's technically pre-COVID. Sorry. I'll restate it. No, no, no, no, it's fine. It's fine. Did I mention I've bumped my head, so my numerical

understanding is not as great as it might normally be. Well, in 2018 and 2019, their plans announced and enacted to build new production sawmills in the U.S. South to take advantage of the larger fiber basket forest logs down there versus the Canadian fiber basket. And it is was than is the Canadians who were doing that investment they own over 50% of the U.S. South production and a lot of those projects got delayed and for COVID reasons they couldn't get their sawmills built they couldn't get them staffed but now they can't so a lot of those projects are now online and they are not going to get shut down there's debt to service there's cash flow motivations to just run who cares what the break even is so we have that we have repaired supply chains

the hangover of the pull forward demand of repair and remodel. And then, you know, the single family stories, you know, at this point. So when Stinson first mentioned, when he said repair and remodel is actually the biggest category. Like at first, I was kind of surprised by that. But, you know, I would have thought single family was a bigger source of demand. But it occurred to me that there is a connection here between what we've talked about in some of our recent conversation with Brad Jacobs, where he made the point that like the U.S. housing stock is really old right now. And there is just And houses have to be repaired. They're like any other asset, especially the moment you buy a house, it starts to fall apart.

And so if we have this historically old housing market, that is just a big source of ongoing structural demand, right, just to keep those homes in existence for all kinds of materials they might need. So that actually sort of makes sense to me. I feel like this is something you internalize as soon as you actually buy your first house. No, no, no, no, for real. I bought my apartment in Manhattan, and it would never have. had any issues and then literally like a window started leaking. Like literally that week. It was so

perfect. Wait, so Stinson, you mentioned something interesting, which is this idea of the mills kind of hoarding workers, first of all, but then also just trying to withstand the lower prices and maybe operating at a loss for as long as they can and just sort of waiting to see if they can beat out others who are forced to shut down. What's the sort of differentiating factor in survival for some of these mills? Is it just whoever has access to like extra cash laying around for a rainy day? Or is it mills that maybe have supply agreements with like big builders and big box companies and that sort of thing? You know, I would say, and I'm not honestly the best to speak to this, but I would guess it's these newer, steady-dart mills have the advantage.

They're going to have been located strategically closer to a fiber supply for trees and logs. They are going to have a lot of investment. They're largely public companies that have built these, so they have access to the cash to kind of see, to get to the other side. In the south, it's still, it's much more fragmented as far as their smaller single location, mom and pop type locations, those folks are going to struggle. But then those folks have probably more disciplined and have saved some cash over the last several years. And there's no way to know, but you would think they've made it this far.

They knew 21, 22 wasn't going to be around forever. So they saved some cash where the publics have to disperse their cash. They pay down debt and then pay dividends, yada, yada, yada. So I think the advantage is just the newness of the mill. It because of the state of the art state of the art less man power higher yields out of logs and then a strategic location where the older mills are naturally going to be further away. They're going to have logged everything within their radius and they're having to go further and further away to get their logs. That's the only thing I can think of. And this the structural housing shortage that we all know by evidence by home prices have not crashed.

in the face of 8% mortgages. We know that. The mills know that. And it's just like, well, it's just going to turn and rate cuts. We've got to wait for rate cuts. And here we are. And I don't know and I haven't heard like how long is this runway. Like how long can they bleed?

And I don't know. But it's clearly been longer than most traders had anticipated. Wait, I have a total curveball question, actually. And if you don't want to answer, that's fine. But we actually, this week, we did publish that interview with Brad Jacob. who is trying to do a roll-up of what he calls a highly fragmented building supply industry. And lumber is a building supply, though I don't know if he's going to get into lumber, though maybe he will.

A, from your perspective, does it seem very fragmented to you? And B, let's say Brad listens to odd laws and he hears this smart Stinson fellow and he calls you up. What kind of asset would you buy to create a platform for consolidating this industry? if you had billions of dollars, four and a half billion dollars. Yeah. Storage. Storage. Yeah.

I think the sawmill production business, I learned this when I started out in grains. Yeah. It's just so tough. And you just rather have someone else fool with that. And when they're overproduced, you become their liquidity provider. You give them cash. They give you lumber. And you store it and wait for the supply response to the crap.

And oil traders. taught me this, I think, and when I started in commodities in 14, 15, there's a big contango and the boats, the oil barges, they just float around with no destination because they were getting paid to store it.

And if you have the balance sheet to store your material when no one else needs it, then you're the only one who has it when things change. And there's inevitably going to be a supply response and the lower we go, the more violent it'll be.

But for me, in my niche, it's it's all about storage. I wouldn't be interested in owning a producer. It's just a very, very tough business. Yeah. But if you, if you can store and the balance sheet has a lot to do with that because your liquidity is tied up in inventory. Right.

You know, that's what I would be doing. But I'm a, and I am, we are doing it. But the public, the pressures that public companies have. Yeah. With their lean balance sheets and their lean inventory models. and turning inventory turns. It's hard to execute. So that's why folks like me exist where they can't execute, I can.

So I'll take on that risk. I'll warehouse it. I'll hedge it and wait for things to shake out. And it's not uncommon for me to sell the lumber right back to the same people I'd bought it from. And I'm just able to navigate slower inventory turns than anyone else. Huh. I remember one of the first times we talked to you ever, you spoke about how the industry was slow to build out inventory because of the reasons that you just explained.

You know, the tendency towards efficiency and the desire to be as streamlined as possible. And so when demand starts picking up, it really takes people a lot of time to get hold of the wood, the lumber that they need to actually match it. Is there any sign that that behavior is kind of changing? So I take the point that people like you exist to bridge that gap. do you see more and more industry participants start to build out additional inventory or additional supply just in case, or is it still not really a reality? I think they tried, and that was kind of the top of the market. And it was kind of this whipsaw, like, oh, we need to build inventory.

Everyone builds inventory price was up, and then it crashes because they bought three months worth of inventory. It's almost the same concept of pull forward demand. Instead of spreading it out over three months, they rushed in and bought it. all in within a few weeks. I think folks are back to just in time lean inventories. I don't think they have an interest in building inventory. The cost to do so is expensive with where interest rates are and everyone's very uncomfortable with having low inventory turns. So no, I don't think there's been a lesson learned to have more inventory just in case. I think they tried to learn it

in real time and didn't work out. And more than anything, the interest rates are painful to store inventory. Now, if they ran a grain elevator hedging model, they would know the futures contract is compensating you for the cost of interest, but not everyone is able to execute on that. Yeah, this is an important point, actually, because just on this point specifically, so, right, it's easy enough to say, okay, you're going to buy when it's low and the futures curve and there's a higher price out there that you theoretically be able to sell it at. But you do have to match that against the interest rate.

So it needs to be sufficiently steep, I guess, that curve such that it makes sense for you to hold rather than just like by treasuries or whatever. Yes. Yes, exactly. And there's a level of sophistication. Yeah, that makes sense. That is needed for that. And then, you know, the futures market's small. So the bigger players kind of like, we can't really have a material impact on our risk. we can't put on a big enough position.

Our little futures contract that we adjusted last year is doing much better, but we still have some room to grow. But, you know, there's a reason, well, I'm way over my skis here, but I think a car gill, there's a reason they're private, you know, and I think one of them is they can execute on these fairly sophisticated storage strategies and not really have to explain to everyone, like this is a six month plus ARB and we're going to pay a bunch of

Morgan call and pay a bunch of interests but we're making it up because our cost basis goes lower and lower every time we roll into the next contract that's just a really hard thing to explain to public investors and you know public commodity companies often tell me when I was a consultant you know our investors pay us to have pretty naked exposure to the underlying commodity and that was an uphill battle as a consultant

So I've said, I'll do it. And if you're not hedging, someone's going to hedge for you. And that's me, that's your investors. And there's a level of, you know, just realities of hedging that not everyone can take it manage up. The secret to success is storage. I love it. Wait, just real quickly, 30 second question. You have some other businesses.

I know you have your hands all things in other pods. You're out in the real world and not like in Manhattan. You're like out in the real economy. Do you think if you see a slowdown? today? Gosh, I'm so concentrated in lumber. I thought you're aware of what's going on. I do.

I do. Yeah, it's just like it's so front and center because, you know, it's a reason on the show today. But yeah, there's some other service businesses that are unrelated and uncorrelated that I was in the middle of the hiring when it was so tough to hire quality people. We were just having to raise the wage to find a clearing wage. That has significantly cooled. We're able to hire. whenever we want and then frankly let go of folks without fear of being able to replace them.

Yes, that aspect, it's like, is it too easy? I don't know. It kind of feels like it used to be where the employer had such an advantage over the employee. Like the employee really needed the job. And that's kind of what we're getting like more professional followups. And there's like they are vying for the job versus us vying for them. I think that dynamic has certainly changed. But I wouldn't say there's a material drop-off in activity in these businesses that I see outside of lumber.

Lots more is produced by Carmen Rodriguez and Dashel Bennett with help from Moses Ondom and Kale Brooks. Our sound engineer is Blake Maples. Sage Baumann is the head of Bloomberg podcasts. Please rate, review, and subscribe to Odd Lots and Lots more on your favorite podcast platform. And remember that Bloomberg subscribers can listen to all of our podcasts ad-free by connecting through Apple Podcasts. Thanks for listening.