Lumber’s Slumber: Lingering Into 2024?

Lumber’s Slumber: Lingering Into 2024?

WOOD may be poised to grow if a favorable rate environment arrives next year.

AndrewHecht310x310
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Reviewed by: Lisa Barr
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Edited by: Ron Day

For all of the metaphors about being solid, mighty and more, lumber can be awfully sensitive. An exchange-traded fund may offer a less volatile way to invest in this critical commodity. 

Like copper and crude oil, prices often fluctuate with changes in the U.S. and global economy. In mid-May, Home Depot reported disappointing first-quarter results, with sales declining 4.2%. CEO Ted Decker, in the company’s earnings release, partially blamed lumber: “Our sales for the quarter were below our expectations, primarily driven by lumber deflation.” 

After trading to record highs at well over $1,000 per 1,000 board feet over the past years, lumber prices are sitting at the $500 level.  

Lumber trades in the futures market, but the contracts are highly illiquid, leading to excessive price variance.  

Home Depot expressed its exposure to lumber prices, and many companies have a high sensitivity to wood prices. The iShares Global Timber & Forestry ETF (WOOD) owns a portfolio of lumber-related companies, and tends to move higher and lower with lumber futures prices.  

High Volatility 

In 2021, the old random-length lumber futures reached a record high at over $1,700 per 1,000 board feet. In 2022, wood rallied to a lower high of over $1,400. The highs were eye-opening, as the pre-2018 peak was $493.50.  

Lumber’s price is highly volatile because of low liquidity in the futures arena. Open interest, the total number of open long and short positions in a futures market, and volume determine liquidity.  

Low open interest and volume in lumber cause bids-to-buy to disappear when prices fall and offers-to-sell to evaporate during rallies. Therefore, prices can spike higher or lower to levels that defy rational, logical and reasonable analysis.  

The CME Group attempted to address lumber’s liquidity by introducing a new and improved contract over the past months.   

Improving Liquidity 

Success in the futures arena depends on attracting hedging, trading, investing and other market participants to ensure price interest at all levels.  

The CME replaced the random-length lumber contract with a new physical one in May. The old contract represented 110,000 board feet with delivery for specific grades and locations. The new contract is smaller, at 27,500 board feet, with more flexible delivery and grade requirements.  

While lumber trading remains challenging because of liquidity issues, open interest has been rising. 

 

Lumber Physical July 2023

Source: Barchart 

 

The chart shows the steady rise in open long and short positions over the past months as the new physical lumber futures gain some traction. Meanwhile, the price has been sitting near the $500 per 1,000 board feet level in late May 2023, and has been in a narrow trading range over the past months.  

Explosive and Implosive  

Lumber’s explosive rally that took prices over $1,000 per 1,000 board feet in 2021 and 2022 occurred due to a few reasons such as low mortgage rates, solid demand for new homes and supply shortages due to pandemic supply chain problems. Also, the low open interest and volume in the lumber futures market exacerbated price rises, driving prices to record highs.  

That situation soon reversed, and prices fell as rising inflation pushed the Federal Reserve to boost interest rates. Mortgage rates surged, and credit simultaneously tightened, dampening home sales.  

Homebuyers also delayed buying due to rising recession fears and soaring prices. At the same time, low open interest and volume in the lumber futures market caused bids to evaporate as prices fell, causing them to plunge in an environment with few buyers.  

Reasons to Buy 

At below the $500 per 1,000 board feet level, lumber futures are in a narrow range compared to the past year’s price action. A few factors might set the stage for prices to rebound next year.  

For example, a pause in rate hikes will allow potential homebuyers to become accustomed to the current rate environment, and some will return to the market and purchase new homes. Falling prices—and recent consumer and producer price data suggest this to be the case—would boost new home demand.  

Seasonality is another potential boost. The spring of 2024 could see an increase in new home demand, as it is the construction season after the winter. New home demand will likely be regional, as people seek to move from high-tax to low-tax states.  

WOOD Tracks Lumber 

I watch lumber futures like a hawk, but have never bought or sold one wood contract because of the illiquidity that makes the futures a roach motel.  

A trader or investor can quickly get into a risk position that runs contrary to the current trend, but getting out is another story. The illiquid nature can make disposing of a losing position painful or financially deadly.  

While the most direct route for lumber exposure is the futures market, WOOD owns shares in companies involved in the lumber business. The most recent top holdings include: 

WOOD's Top 10 Holdings

Source: etf.com 

 

The chart highlights the companies held in WOOD’s portfolio. One of WOOD’s most significant holdings is Weyerhaeuser Co., which operates as a real estate investment trust, owning and leasing significant lumber-producing properties in the U.S. and Canada. 

At $71.83 per share, WOOD had nearly $200 million in assets under management. WOOD trades an average of 12,724 shares daily and charges a 0.40% expense ratio. The annual dividend yield of $1.64 per share translates to 2.3%, which covers that fee in under one quarter.  

 

WOOD's 5-Year Returns

Source: etf.com 

 

As etf.com’s fund flow tool highlights, WOOD experienced a $4.34 million inflow since the end of this year’s first quarter.  

 

WOOD 5-yr Price

Source: etf.com 

 

The five-year chart illustrates WOOD’s rise in 2021 and 2022, when lumber futures reached record peaks, and the decline in 2023 as lumber prices plunged. WOOD tends to underperform lumber futures on the upside but outperforms during price corrections.  

Buying WOOD on dips could be the optimal approach to investing in a recovery in the lumber market. While 2023 remains a bearish year for the lumber market, 2024 could usher in a comeback in the industrial commodity.  

Andrew Hecht is a Nevada-based writer and analyst covering stocks, bonds, foreign exchange, cryptocurrency and raw material markets. He has over four decades of experience in markets across all asset classes, concentrating on commodity markets. Hecht was a senior trader at Salomon Brothers in the 1980s and 1990s, running sales and trading businesses. In 2013, McGraw Hill published his book, “How to Make Money in Commodities."