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Industry Insights

May202021
Understanding the Lumber and Steel Boom and Your Options

John Fitzgerald, CPA

5.20.21 | Industry Insights

Perhaps we could call it the ‘COVID Paradox’: Amid the COVID-19 pandemic and the subsequent recession, the U.S. housing market experienced a nearly unprecedented boom. The boom was driven by the highest level of mortgage originations recorded by the New York Federal Reserve since it began tracking mortgage data in 2000. In the final three months of 2020, mortgage originations reached $1.2 trillion. But booms have consequences that have swept through the lumber and steel industries, and there are steps you can take in the face of all this volatility.

The Drivers

First-time home buyers and repeat buyers looking for second homes and investment properties have sent prices—and, consequently, the price of building materials—soaring. During COVID-19, more and more homeowners have been cashing out home equity and funneling it into home improvements. By one account, deck construction is up 275%, while fence installations rose 144%.

According to a report by the New York Fed, “Homeowners withdrew $188 billion in home equity over the course of 2020.” This tsunami of new cash flowing into the economy along with the U.S. government’s $1.9 trillion stimulus package has driven home prices and the prices of raw materials such as lumber and steel higher and higher. “With housing starts increasing at the current rate, to throw the Biden infrastructure plan on top of it would only increase demand and continue to drive the price of lumber higher for the foreseeable future,” says Andrew Goodman, President, and CEO of Sherwood Lumber. Should the Biden Administration’s proposed $2.3 trillion infrastructure bill become law, expectations are that these prices will go even higher. Some estimate that the Biden infrastructure plan would require 5 million tons of steel and provide a boost in aluminum and copper demand as well.

Other contributing factors to the increase in raw materials can also be triggered by labor and construction slowdowns caused by shutdowns in the second quarter of 2020, supply chain disruptions resulting from shipping delays and port traffic, and the stockpiling of supplies by companies to keep up with demand.

But even in the absence of any additional stimulus, raw materials such as lumber have already spiked significantly, up 340% from a year ago. Part of the reason for this is the aforementioned housing market and home improvement boom. Another part can be tied to the 20% tariff placed on Canadian timber by the Trump administration (which was subsequently lowered to 9%), as well as Canada’s strict forest laws and timber regulations. “The dispute with Canada has been ongoing for many years, and these kinds of tariffs always cause more volatility in the price of lumber,” notes Goodman.  Not surprisingly, companies specializing in forest products have seen their stock prices go up. Weyerhaeuser, for example, is up 125% this year. U.S. lumber prices reached an all-time high at $1,500 per thousand board-feet. Nevertheless, there is some hope that lumber prices have peaked and may eventually adjust downward.

Expectations of a coming infrastructure stimulus are also driving the prices of raw materials like iron ore, copper, and steel higher. In April, the Bloomberg Commodity Index had its best month since August 2020. Still more, according to a recent report in Barron’s, steel futures are up 40%, while iron ore futures are trading nearly 7% higher. “The CRU price index on hot-rolled sheet hit $1,491/ton as of May 12. This is an increase of $887/ton since the $604/ton published price on October 7. That equates to a $44.35/cwt increase in 7 months with prices still climbing,” says Bob Lasky, President, American Strip Steel Inc.® /WARE Industries Inc.

The price of copper is up 90% year-over-year, trading at over $10,000 for the first time since 2011. Part of the reason behind the spike in copper prices has to do with expectations in changing global policies that are pushing “green” energy alternatives. The demand for low carbon energy alternatives—from electric cars to solar energy panels—is driving the need for newer and bigger power grids.

Lasky adds: “Availability for all spot steel products has been very tight if not non-existent, especially carbon flat-rolled, which supplies the automotive, appliance, and construction industries.” Meantime, the price of iron ore has nearly doubled. Some of this can also be attributed to the U.S. stimulus plan. Others note that the commodities rally is being partly driven by expectations of a post-COVID-19 boom. The reopening of global trade, as well as China’s decision to cut back on steel and aluminum production, has also contributed to the spike in commodity prices (China is the world’s leading steel producer). UBS is expecting a 10% rise in global commodity prices this year.

A Coming “Supercycle”?

Recently, prices for timber, iron ore, and palladium (a key metal used by car manufacturers) all hit record highs. As we have seen, market analysts are predicting the boom to continue through 2021. Some believe we are approaching a so-called “supercycle”—a decades-long period in which demand outstrips supply. It is believed that this supercycle will be driven by simultaneous post-COVID-19 economic recoveries in Europe, China, and the U.S. Saad Rahim, the chief economist at Trafigura, a commodity trader, recently told the Financial Times that should the new Biden stimulus plan get passed, “you are just supercharging this whole thing.”

There have been four previous commodity “supercycles.” American industrialization in the 1890s and the onset of the First World War drove a period of higher commodity prices that lasted until the Great Depression. The second cycle began with the Second World War and lasted until the early 1950s. The third took off in the early 1970s with the surge in energy prices. The fourth and most recent took place at the beginning of this century with China’s accession into the WTO.

Whether or not we stand at the cusp of another is too early to tell. From Andrew Goodman’s perspective: “As lumber wholesalers/distributors, we can only focus on what we can control, which is having enough material on the shelves for our customers. The price will work itself out, and we will react accordingly.”

Yet, even if we are on that cusp, the implications are not all rosy. Some analysts caution that commodities prices are notoriously fickle. While the news is good right now, it is likely due to the rapid post-COVID-19 reopening and is consequentially not sustainable. Others note that the increase in the cost of lumber and other raw materials will push up prices and cause inflation. We are seeing this play out already in the housing market: The record-setting spike in the price of lumber has, by some estimates, increased the cost of new single-family homes by nearly $36,000.

Important Steps During Volatile Times

Managing the volatility of these raw material increases may be crucial to sustaining your company’s financial stability. Maintaining continuous communication with vendors and monitoring the ever-changing situation will be vital in forecasting and budgeting. Companies need to calculate possible further price increases in job costing and inventory replenishment. Another consideration would be to adopt the use of hedging derivatives for price protection with vendors. Investing in research and development (R&D) as well as evaluating the viability of alternative materials such as recyclables or engineered products may also be worth exploring. Investing in R&D may also result in eligibility for R&D tax incentive programs offered through federal and local government programs.

Questions: Contact John Fitzgerald at 212.331.7411 | jfitzgerald@berdonllp.com or reach out to your Berdon advisor.

Berdon LLP New York Accountants

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