Construction Activity Falls, Material Prices Rise

Activity in the nonresidential construction market has not yet fallen as drastically as residential construction but we expect the winds to change. Private nonresidential construction spending slipped 0.4% in December. Financing for commercial real estate has tightened and the need for extra office and retail space has disappeared along with consumer spending and employment. IHS Global Insight expects spending on private nonresidential construction to decline 12.2% in 2009 and another 18.6% in 2010.

In principle, the downturn in construction activity should translate into a decline in building material prices. That is indeed true for lumber products, which declined 7.3% in 2007 and another 6.5% in 2008. Prices for lumber products are expected to continue their downward spiral this year as the residential construction market continues to weaken. However, not all building material prices are declining; in fact, some material prices are even on the upswing.

Gypsum wallboard prices, for example, have begun to show strength again after plummeting on a year-over-year basis since the second quarter of 2007. While the construction market has weakened further since that period, gypsum prices increased 5.0% y/y in the final quarter of 2008. The question then becomes: if demand is falling, how are producers able to push through higher prices? The answer lies on the supply side. Producers have been aggressively cutting back production in reaction to falling demand. Throughout 2008, mined gypsum was on the decline. In November, crude mined gypsum was down 56.8% y/y and synthetic gypsum dropped 15.9% y/y. Crude gypsum imports also declined, 38.6% y/y in November. Falling consumption levels have been met with even steeper declines in production and thus have caused an up-tick in prices. After gypsum prices declined 9.8% in 2008, we believe prices will increase 1.8% in 2009.

The story is similar in the cement industry. Falling demand has not been met with falling prices. Cement prices increased 1.4% in January and we expect prices to remain afloat throughout 2009 and 2010. Again looking at the supply side of the equation, total cement shipments declined 27.9% in November and are off 29.1% y/y. Imports plunged 53.7% y/y in November. Falling shipments and imports will keep cement prices from dropping off with demand as the construction industry continues to decline along with the U.S. economy.