Timberrr!

In the current "Rally of Everything" market there is one thing that stands out to me. The price of lumber. As a die-hard commodity guy from way back, it has both surprised and encouraged me to see this once left-for-dead commodity soar to all-time highs. But trees don't grow to the sky and neither do commodity prices.

The formative years of my career gave me an insight into the inner workings of the physical commodities markets. The interplay between the real-world buying and selling of things that hurt when dropped on one's foot and the financial markets were a fascinating and ultimately financially rewarding training ground. Many trips to smelly pulp mills, sketchy lumber mills, and dismal rail car yards gave me insights that few desk-bound stock traders or generalist PMs were able to acquire. In comparison to the dynamic oil and gas sector for which I was also responsible, the more mundane bulk commodities such as fertilizer, petrochemicals, and wood products seemed sleepy - just like most of the sell-side analysts that covered them. Ah, the 80's - I do miss them.

But as the service economy began to eclipse the smoke-stack world of the late 20th century, many of these sectors faded from view and investment importance. Technology and Consumer Discretionary sectors have dominated for years now. Hard assets became the soft spots in most portfolios. As I pointed out last week, the revenge of these nerdy assets has begun. Commodities are back with a vengeance. From Agri-products to Zircon, scarcity of real-world assets is now a playable theme that should last.

The current run-up, or more appropriately, a short squeeze, in the physical lumber markets, is a result of a confluence of supply and demand factors that have been years in the making. The lowest mortgage rates in years, combined with a huge pent-up demand for housing from the new home buying Gen-X, Y, and Millenials, created a sudden surge in home demand. At the same time, supply was artificially suppressed by lack of mill capacity and systemic inventory shortages. The once-bitten, twice-shy forest industry was in no position to respond to this sudden demand surge. The memories of 2008, were fresh in their minds as they watched lumber prices that soared well beyond the previous record highs of $600. Governments also did their part in fuelling the price explosion by having previously curtailed the Allowable Annual Cut and recently slapping duties on exports, further limiting a supply response. A perfect bull-market storm.

Relative to other commodities, lumber looks stretched. The charts below show just how elevated the price of lumber is compared to the now-recovered copper and oil markets. But also notice that lumber prices have come out of multi-year bases relative to both commodities. This move was long overdue.

Lumber/Copper Relative Price

Lumber/Oil Relative Price

I believe the factors that created this price rise are likely to reverse over the next few months. As the saying goes in commodities, the cure for high prices is high prices. But just before you get all bearish, think about the bigger picture. Environmental concerns are likely to continue to attenuate any market-driven supply response for commodities over the next number of years. Extractive industries are facing increasing pressure to limit expansions and downsize environmental footprints the world over. The barriers to resource capital expansion are not just from the environment but also socio-political. Just ask any promoter of a pipeline and they will tell you how hard it is to expand. The Trans Mountain Pipeline construction has been held up by the discovery of rare hummingbird nests. And that's even before the project starts to fully engage with Burnaby's NIMBY protesters.

So, I get that the current price run-up for commodities is potentially no different than Bitcoin's recent bull-run. More buyers than sellers - forget the why. The Fed's liquidity shot-gun has scattered its effects far and wide. Record-level easy financial conditions have led to indiscriminate asset inflation, floating all boats. Some of the distorting effects will unwind when the Fed starts to 'think about thinking' of tightening later this year. It won't take much, as the hype surrounding the re-opening economy starts to fade, after the Q2 statistical lapping of the 2020 pandemic affected numbers runs its course.

I'm at risk of missing the last final push here, I know. But I think it's prudent to hold off chasing this next move. Oil looks 'done' already, given the global third-wave Covid scare now accelerating.

One thing I know about commodities is, they never just go sideways for long. They usually fall like trees in a forest. The only difference is - this time we will hear it. Timberrrr!

Risk Model: 4/5 - Risk On

The Model's RSI Factor has gone positive, helped by the pause for breath in the markets recently. That has allowed for the mini-rotations to correct the excesses created by the re-opening trade and let the market wait for the earnings to backfill the now extended valuations. So far so good. Banks were good. Tesla snuck in a beat, if only using their Bitcoin and enviro-credit profits. Big tech will report this week and should show a solid quarter. The biggest question mark, the Fed policy stance, will also be revealed tomorrow. It is unlikely that they want to rock the boat just yet. In Washington, tax talk has dominated, but only the 1% crowd is scared. Not enough to derail the recovery. Small Caps are digging in their heels as well.

We are now set up for another run for the reopening roses. All the while, it will continue to be a game of 'chicken' between liquidity-fuelled asset inflation and a Fed willing to 'let it run hot'. The sooner the Fed realizes that the better. If fear they have painted themselves into a 'behind the curve' corner, however. So I can't rule out $5 copper first. This could be the first time since the seventies that the risk of a policy error is the Fed being 'too easy' for too long!