It seems one of the big hindrances to our current economic malaise might finally be letting up.
Numerous pieces of data are all pointing to the same thing: a sustained recovery in housing. The S&P Case-Shiller composite index — which measures home values in 20 metropolitan areas — continues to rise, while new construction starts and pending home sales are increasing. Heck, even shares of the hated homebuilders have been headed skyward for the past year, and several builders — like TRI Pointe Homes (TPH) and William Lyon Homes (WLH) — have recently gone public.
All in all, it seems that housing is finally back in the U.S.A. So why exactly is lumber in the dumps?
Futures contracts for both Chicago-traded random-length lumber and oriented strand board have plunged during recent weeks despite the gains in housing stocks. Is there something sinister going on here … or are investors being given a great opportunity to load up on timber-producing players?
Deepest Streak of Losses
Back in 2012, lumber futures surged more than 44% on the back on the housing recovery. Given the data pointing to continued housing improvement, many analysts estimated that 2013 would be another good year and would produce similar results for the commodity. During the first three months of the year, lumber prices rallied, seemingly validating that analysis. However, lumber’s recent price movements have been anything but stellar.
Prices for the critical building material have now dipped below $300 per thousand board feet for the first time since October and have declined more than 25% since reaching an eight-year high of $400.80 per back in February. That’s the deepest streak of losses in nearly a year-and-a-half.
Those prices have decreased despite continued gains in housing starts, new residential and commercial construction as well as improving earnings from homebuilders like Toll Brothers (TOL).
So what’s the reason lumber prices haven’t kept up with housing? In this case, it all comes back to supply and demand.
First, with prices for lumber hitting record highs, many timber producers have restarted idled mills to take advantage of potential profits. That fact has unleashed a torrent of supply onto the market. According to estimates by Canadian bank CIBC, about 55.5 billion board feet of lumber will be produced this year. That’s nearly a 6.7% increase vs. 2012’s production and represents the fastest pace of production gains in nearly six years.
While some of that increased supply will be absorbed by the jump in new housing starts in the U.S., the real issue is coming from outside our borders.
Exports on the West Coast to key regions in Asia (i.e. China) have taken a dip as of late. Log exports during the first quarter of 2013 fell 33% to hit just 242 million board feet from West Coast ports as buyers in Asia sought cheaper alternative suppliers. North America is a major supplier of softwood products to China, with the market share for lumber and logs accounting for 51% of its imports. With high futures prices, places like Brazil, Chile and New Zealand have taken a bigger share of that pie.
Given the potential excess supply coupled with dwindling export demand, it’s easy to see why lumber prices have dipped and share prices of producers down along with them.
A Buying Opportunity
Despite the drops, investors might have a nice buying opportunity on their hands.
Shares of the big timber real estate investment trusts — Weyerhaeuser (WY), Plum Creek (PCL), Rayonier (RYN) and Potlatch (PCH) — have all dipped pretty hard over the past few weeks as lumber prices have tumbled. However, the timber futures pullback could be viewed simply as correction rather than a fundamental change in lumber pricing trends.
Analysts estimate that China imported about 4 billion board feet of lumber from North America throughout 2012. Even with its economy slowing as of late, the nation will need to grow those imports to around 6 billion per year over the next three to four years. That will have the country scouring the globe for new sources of supply and will bring right back to North America.
Meanwhile, the U.S. housing industry is really just starting to get going and is far from pre-recession numbers. Based on today’s data, predictions now show that U.S. housing activity will approach and then surpasses 1.4 million housing starts by 2015 or 2016. That number of newly constructed houses will keep the North American lumber supply chain challenged as there are simply so many mills that have been permanently idled in the wake of the recession.
Then there are the pesky environmental factors — like the direct loss of forest acreage via farmland cultivation, and pests like the Asian longhorn and pine beetle — to consider. Both of which will hinder supplies going forward.
Both the Royal Bank of Canada and CIBC now expect prices for lumber to average around $360 per thousand board feet in 2013. That’s still about $70 above current levels and makes the big drop in the timber REITs potentially unjustified, given the longer-term rosy picture.
All in all, these bullish factors make a pretty nice case for these quality lumber firms — all of which yield around 3%. However, that opportunity might not last forever as housing continues to show its strength.
As of this writing, Aaron Levitt was long WY, PCH, RYN and PCL.