Lumber erases all 2021 gains, here's why deflation is the risk to watch, says Bloomberg Intelligence
(Kitco News) Lumber was one of the best-performing commodities this year, with many pointing to the price rally as a sign of accelerating inflation. But lumber's recent dramatic drop, which erased all the year-to-date gains, could be a sign that deflation is the risk investors need to watch, according to Bloomberg Intelligence.
"Lumber may indicate deflation is a greater risk," said Bloomberg Intelligence senior commodity strategist Mike McGlone.
McGlone looked at more than two decades worth of timber and consumer price history, noting that analysis points to lumber futures going even lower.
"The pandemic is more likely to mark an aberration amid longer-term relationships, which we believe should normalize. Indicating the deflationary forces predominant from commodities, the almost 25- year change in timber prices is closer to 20% vs. around 75% for the CPI," he said. "In March 2020, lumber futures were hovering at par with timber. The pandemic boost is unlikely to be sustained if timber prices and history are guides."
What's the Cure for High #Commodity Prices? #Lumber May Know - The old adage that commodity prices have limited upside due to a primary factor -- supply elasticity -- may be more relevant than ever, we believe. Price peaks from 1H in lumber, #inflation #copper, #corn & #soybeans pic.twitter.com/Jmg8UTxPg1— Mike McGlone (@mikemcglone11) July 13, 2021
Lumber is now back to trading flat on the year after rising more than 120% since the start of 2021 when it hit record highs in May. At the time of writing, lumber for September delivery was down 6.1% on the day and trading at $669 per thousand board feet on the CME.
"Free-market capitalism and the rules of supply and demand may be gaining relevance amid rapidly advancing technology for most commodities," McGlone said. "The old adage that commodity prices have limited upside due to a primary factor -- supply elasticity -- may be more relevant than ever."
After catching the markets off guard and triggering inflation fears, the lumber price rally seems to be over.
"The initial demand shock from the pandemic-related shift away from living in cities could be more transitory than the supply elasticity of lumber," McGlone noted. "Former Trump administration trade restrictions and an enduring period of moribund prices resulted in a near-perfect storm for a pop in lumber. Demand vs. supply economics should prevail though, pressuring levels back toward longer-term trends as evidenced by the tame price and ample supply of timber."
And it is not just lumber. Soybeans are also giving back their 2021 gains, and copper is on the decline as well, McGlone added.
Even Federal Reserve Chair Jerome Powell highlighted the temporary surge in commodities such as lumber as evidence that inflation will be "transitory."
"The problem right now is that the demand is very strong, and incomes are high," Powell said in June. "If you look behind the headline numbers, you'll see that the incoming data are consistent with the view that prices that are driving that higher inflation is from categories that are being directly affected by the recovery from the pandemic and the reopening of the economy."
Powell drew parallels between the transitory inflation and the temporary surge in lumber prices.
"Over time, these things driving up inflation will be temporary … The experience with lumber prices is illustrative of this. Prices that have moved up really quickly because of the shortages and bottlenecks should stop going up. And in some cases should actually go down. And we did see that in the case of lumber," he said. "Our expectation is that these high inflation readings that we're seeing now will start to abate. And it'll be like the lumber experience."
In the meantime, inflation data is still coming in hot. The latest CPI numbers out of the U.S. showed that annual inflation was running at 5.4% in June. And the core measure, which excludes the volatile food and energy components, climbed to 4.5% from June 2020, the largest increase since November 1991.
The June numbers were much higher than the market consensus, which projected 4.9% for the annual CPI and 4% for the core CPI measure.