Editorial by Ethan Fisher – A good friend of the Group.
Energy: For the three-month period ended 9/30, we saw NY gas prices fall ~23% from the 4.70s to 3.60s in line with the general macro retracement. Originally exacerbated by Putin’s aggression and the politics of the Nord Stream Pipeline, we have now seen the efforts of EU energy transition reform and subsidization of energy costs (Gas Price Capping) start to show. Beyond the current environment, a look at the futures market suggests a continuation of the downward trend as reflected in the -10% difference between the Nov22 and Jul23 contracts. This expectation should be taken with a grain of salt, considering OPEC self-serves, as their October 5th announcement offered a production cut of 2 Million barrels/day or 5% of the current 44million barrels/day. Keeping in mind that OPEC is most heavily influenced by the Saudis, we won’t see any of their efforts in thwarting off high prices. Moreover, if OPEC is looking at production cuts it helps confirm the expectation that oil prices have more room to slide and the Saudi’s want to slow the fall. On the home front, the US continues to lead the pack as the largest producer, 11.1 million barrels per day and has opened discussions with Venezuela in the hopes of identifying possible back fill producers. Venezuela has long underserved its total oil production capacity to command higher prices. I see gas prices cooling their already cooled jets over the next year given macro tensions staying course. Considering that oil is involved in the production of just about everything under the sun, a pullback in prices will be a noticeable force against the never-ending ascension of consumer and producer prices.
Commodities: We last touched on Lumber prices in February and March where I posited that we would not be seeing price relief until May. Drum roll please…. Looking at the spot rate at the tail end of May, prices took a beautiful swan dive from their regained 21’ highs ~900-1000, saw no splash through the $6-800s and were found treading water in the mid-500s. There are several factors that contributed to this decline that I had highlighted in previous analyses. This year we have witnessed five federal reserve rate hikes, totaling a +300 basis point move (.25-3.25%). The federal funds rate is the World’s life blood in the ever-hungry global growth mindset. This severely limits access to affordable capital with a strong currency base. The fed started their movement in March and then in May totaling +75 basis points. Simultaneously we see building permits drop -8.5% from ~1.85 million for Dec21-Apr22 to ~1.7 million for the period May22-Jul22, followed by another -8.5% from Jul22-Aug22. I am foreseeing a leveling off in lumber prices as Canadian and domestic producers roll back production volume to maintain current prices. Leveling out could result in some upward movement in the late 1Q23 to early 2Q23 period.
Steel followed the general downward price trend starting in May and leveling off in Jul-Aug. This can again be supported by new builds, interest rates and especially by the pullback in manufacturing orders. New manufacturing orders have fallen by 22% YTD (Sep 2022 ending) and can be used as a leading indicator as we saw initial contractions in Feb22-Mar22 period which was followed by the commodity price contraction. Similar to Lumber, I foresee more reasonable price fluctuations through end of 2022 with some upward pressure going into mid-2023. All with basis that we see the maintaining of current global tensions. If there is any breakout of new conflict, hats are off, and we will see major policy shifts, likely towards defense spending which can be quite beneficial to manufacturers and represents a good multi-faceted investment opportunity.
Global Outlook: In addition to the slowing domestic demand, I would again like to point out the devastation that China has been dealing with in their property sector. The completely over leveraged investments saw developer’s default across the board and construction projects skid to complete halts, some even being demolished. Considering the current microenvironment, a ~12% YoY decline in home prices, ill minded Covid-Policy, and restrictions on citizens withdrawing money from checking and savings account, China has been an increasingly hot topic for civil unrest and general dissatisfaction. China remains one of the largest consumers of building materials and for them to go cold turkey has caused a significant shift in what prices global producers can command. The People’s Republic is diligent in dealing with civil unrest as we have seen time and time again so I would not be surprised to see continual pressure on relations with Taiwan. For means of distraction and a bump in manufacturing sector for defense. We have seen global bond and currency rates fall against the US Dollar; meaning we will be looking outward for pricing arbitrage, an increase in overall imports. With the current relative strength of the US dollar, those who cast a global net for production needs can benefit from easing supply chain pressure and advantageous fx rates. The unending tragedy in Ukraine brought about by the Russians has caused massive disruptions for oil hungry nations like the EU who rely on Russia for 40% of their energy needs. Add in an unexpected strike on the Nord Stream Pipeline 2 and the EU is left with only the government subsidization and price capping of energy costs for its populous to make it through the winter. The tensions remain high and there does not seem to be any deals/negotiations for an off-ramp. NATO countries continue to shut Russia out from nearly all economic activity and the recent talks between Russia and China are cause for a wary eye, but let’s pray that they were purely economical and discussed opportunities outside of conflict. My guess would be that China has watched Russia blow through military inventory at an incredulous rate and would rather the only other off brand communist behemoth ease up on the complete waste devastation of resources and mankind.
Citations:
Lumber Reports: https://madisonsreport.com/ (8/5/2022)
Lumber Prices: https://www.nasdaq.com/market-activity/commodities/lbs and https://www.cmegroup.com/markets/agriculture/lumber-and-softs/random-length-lumber.html
Steel Prices: https://tradingeconomics.com/commodity/steel and https://www.marketwatch.com/investing/future/hrn00
Building Permits: https://tradingeconomics.com/united-states/building-permits
Manufacturing Index: https://ycharts.com/indicators/us_ism_manufacturing_new_orders_index
Fed Rate Hikes: https://www.forbes.com/advisor/investing/fed-funds-rate-history/
Steel Prices: https://tradingeconomics.com/commodity/steel
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