Are lumber markets converging into a single global market?
April 23, 2013
In Home or abroad? The changing patterns of provincial lumber shipments, we raised the possibility that provincial shipments with very different destinations could be displaying similar patterns of evolution because lumber markets might be integrated.
Market integration implies that markets in different regions are dependent on each other so that market events in one region impact the market in another. For example, a lumber shortage in China would drive up prices on the U.S. east cost. Getting insight into whether lumber markets are integrated is an important component of understanding price and shipment movements. In this context, the Law of One Price (LOP) says that if markets are efficient, the price of all identical goods should be the same everywhere accounting for transportation costs. The implication is that if markets in different regions are integrating, they will show narrowing gaps between prices. Let’s take a look at the implied lumber prices in various countries:
Figure 1: Implied lumber prices in fifteen of the world largest lumber importing countries (imported lumber quantity divided by imported lumber value)
It appears that prices became increasingly variable from the 60’s into early 2000’s, before converging again. Beyond simple observations, a more rigorous measure of long-term price convergence is the Sigma convergence, measured as the coefficient of variation - the standard deviation divided by the mean - over time for the prices included. If the coefficient of variation is decreasing over time, this means that prices are converging. The sigma convergence of lumber prices for the same countries pictured above show a slightly increasing trend until 1998 (Figure 2). The sigma convergence has since decreased very sharply, a strong indication that markets might indeed be integrating and at a rapid pace.
Figure 2: Sigma convergence of lumber prices in fifteen of the world largest lumber importing countries
Two broad categories of factors can lead to price convergence: the removal of institutional, trade and other barriers and technological improvement that facilitate transport. The International Monetary Fund (IMF) has noticed that economies have been getting more integrated since the late 1990’s linking this phenomenon directly to a boom of economic activities in what was traditionally considered developing or emerging economies. Essentially, the late 1990’s appeared to be the start of a new era with an enlarged supplier base, an enlarged consumer base, an increasing homogenisation of these consumers and easier means to reach them through improvement of transport and communication technologies (see Dimensions of Globalization [1.18 MB PDF]).
In this new context, lumber prices could continue to converge, which could offer Canadian producers some level of buffer against price volatility induced by local (or U.S.) supply and demand perturbations.