Is Lumber the Leading Indicator of U.S. Commodity Markets?

Industry News,

Originally Published by: MarketWatch — July 14, 2022
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The lumber market has taken some big hits from rising inflation and a slowdown in the housing market, with lumber prices down more than 40% in the first six months of the year. They could fall still further before bottoming out.

Lumber has bucked the overall uptrend in the commodities market. The S&P Goldman Sachs Commodity Index SPGSCI, -1.09%, composed of 24 exchange-traded commodity futures contracts, jumped 26% in 2022’s first half, though has moved lower in the third quarter.

Lumber futures prices were among the few decliners in the first half of the year. GEORGE FREY/GETTY IMAGES

“Lumber truly has its Ph.D. in trading and is the ultimate canary in the coal mine when it comes to being a leading indicator for all other commodities,” says Greg Kuta, president and CEO of lumber broker Westline Capital Strategies. “The inherent volatility in lumber pricing is highly sensitive to both demand and supply dynamics, and is very quick to reflect changes in demand and supply on a micro level.”

Lumber futures LBU22, -0.31% LB00, -0.31% gained 83% in the fourth quarter of 2021 as demand for housing exploded. It ended that year at $1,147.90 per thousand board feet, but lost roughly half that rise in the first two quarters of 2022. On the cue of the canary, many other commodities have started to fall, including oil CL.1, 0.83% BRN00, +0.87%, wheat W00, -0.46%, and copper HG00, -0.54%.

The increase in U.S. interest rates, along with the “one-off 2021 [repair and remodeling] demand,” lined up to be the “perfect storm in creating demand destruction in housing and lumber,” says Kuta.

The Federal Reserve raised the federal-funds rate by 75 basis points in June, the largest increase since 1994, in an effort to tame inflation.

“Inflation pressures have led to rising interest rates and a slowing of housing starts, and lumber buyers have…started to slow their orders,” says Scott Reaves, director of forest operations at Domain Timber Advisors.

Construction started on new U.S. homes dropped more than 14% in May, with the annual rate of total housing starts falling to 1.55 million, according to the Commerce Department.

Lumber prices have fallen from the “extreme levels seen throughout the pandemic,” but they still remain significantly higher from levels seen before the pandemic, says Reaves.

Lumber futures traded around $407 at the start of 2020, and hit a record high above $1,670.50 in May 2021. They stood at $683.30 on July 13.

U.S. timber supplies and land are being consumed at increasing rates, Reaves says, suggesting that real assets that serve as inflation hedges, such as timberland, may be a good focus for traders.

The move down in lumber probably got a bit ahead of itself, says Steve Loebner, director of risk management at Sherwood Lumber. The reality is that while single-family housing demand is slowing, there is still a “tremendous amount of business in the pipeline, and many builders have [three to five] months of solid backlog as they attempt to finish projects that are already in play,” he says.

So, “we are faced with a market that is gradually slowing overall, but by no means falling off a cliff,” says Loebner.

Meanwhile, the CME Group will launch a new lumber futures contract next month, with sizing of the contract at 27,500 board feet— a fourth the size of the current contracts.

Kuta refers to the new contract size as “truck based,” a useful measure because majority of end users, such as retail yards and home builders, buy and sell by the truckload.

“It will be a very positive change for the industry, leading to increased participation and liquidity, with the idea of streamlining the jaggedness of the peaks and valleys in lumber prices,” he says.

For the rest of the year, Kuta sees spot lumber prices in the $400 to $450 range on the low end, with prices at the high end in the $650 to $800 area.

“Recessionary fears, inflation ramifications, and Fed credibility will go a long way in influencing all markets, including lumber,” says Kuta. Unless fundamentals are supportive, “be very skeptical in chasing upward price momentum.”