Will WOOD Grow Amid Housing Shortage?

In real estate, location, location, location is the mantra. In futures markets, they speak of liquidity, liquidity, liquidity.

In home construction, which requires lumber, the phrase is supply and demand. And demand for homes is far outstripping supply. 

The iShares Global Timber & Forestry ETF (WOOD), launched in 2016, offers liquidity while also tending to track lumber prices. The $190.4 million fund tracks an index of the 25 largest publicly listed companies from developed and emerging markets that own or manage forests and timberlands. 

For a little background: After trading commodities for more than 40 years, with risk positions in nearly every raw material market, I still haven’t bought or sold a single lumber contract. 

The country is running short of single-family homes. Since 2012, about the number of new households exceeds new single-family homes by about 7.2 million, according to Realtor.com (multi-family home construction cut the gap to 2.5 million homes).

What does this mean for lumber demand, and investing in ETFs covering the market?

Last year, the Chicago Mercantile Exchange replaced the random-length lumber futures contract with the physical lumber futures product. The physical lumber futures offer smaller contracts with more flexible delivery options. 

However, the critical factors determining liquidity, open interest, and volume haven’t increased since the transition. Low liquidity leads to high price variance, a hallmark of the lumber futures arena.

While lumber futures are untradeable, they are a crucial benchmark for the industrial commodity.

Lumber: A Seasonal Commodity, Crucial to Home Building 

Lumber is a leading industrial commodity, and like oil and copper, a bellwether market for economic growth or contraction.

Lumber is a critical component in new home building and tends to experience seasonality as construction projects decline during winter and increase in spring and summer. Favorable weather tends to lift demand, along with prices. 

Futures markets suffering from limited liquidity tend to experience significant price volatility as offers to sell disappear during rallies and bids to purchase evaporate during declines. Over the past few years, the price action in the lumber futures arena has shown explosive and implosive price action.

Rising interest rates that weighed on new home demand have been bearish for lumber prices and prices have remained below $600 per 1,000 board feet throughout most of 2023. Random-length and physical lumber futures soared to $1,711.20 in May 2021. Before prices started rising in 2018, the all-time high in lumber futures was $493.50 in 1993. 

Rates and New Homes 

As of late 2023, inflationary pressures are receding, with the consumer and producer price index data moving towards the Fed’s 2% target level. 

In 2023, hawkish monetary policy that tightened credit pushed mortgage rates over the 8% level at the high. In late February 2024, the rate is hovering around the 7% level, still double where they were before 2022.

High mortgage rates weigh on the demand for new and existing home purchases. The move to 7% in mortgage rates has increased monthly payments on a $400,000 mortgage by over $1,300.

While high rates reduced the addressable market for home purchases, existing home prices remain relatively high. The existing home inventories have dried up because homeowners who purchased or refinanced homes when rates were 3% or lower are not moving any time soon. Therefore, the demand for new home construction remains robust in the current environment, supporting lumber demand.

Meanwhile, as the market digests the higher interest rate environment with home prices steady, more buyers could appear over the coming months as pent-up demand has increased.

WOOD Follows Lumber Over Time

Lumber is approaching the time of year when the price tends to move to seasonal highs. While the lumber futures arena’s low liquidity makes it dangerous for any risk position, WOOD tends to follow lumber prices higher and lower.

At $76.94 per share, WOOD had nearly $200 million in assets under management. WOOD trades an average of over 9,500 shares daily and charges a 0.42% management fee. Nearby lumber futures closed 2023 at $543.50 per 1,000 board feet and were 3.9% higher at $564.50 on February 23.

WOOD reached a record high in May 2021 when lumber prices peaked at over $1,700 per 1,000 board feel. Meanwhile, in 2024, WOOD declined 5.4%, falling from $81.30 at the end of last year to $76.94 on February 23.

Fund flows are a critical market sentiment indicator. When funds flow into a product, it supports higher prices and vice versa.

The etf.com Fund Flows Tool shows nearly $14 million has flown out of WOOD in 2024, validating the price weakness. However, lumber is a highly volatile commodity that tends to peak in spring, which could mean WOOD will find a 2024 bottom over the coming days and weeks. Any improvement in the housing market will support lumber and WOOD. 

Real estate is all about location, while futures are all about liquidity. Stay away from lumber futures, but WOOD has the requisite liquidity to provide exposure to the volatile lumber market.