When it comes down to it, lumber is at the core of my research. It’s now been eight years since my original research paper talked about the relationship between lumber and gold and how its predictive nature could help mitigate portfolio risk. Still, it’s lumber that is the straw that stirs the drink. As I’ve said often, lumber prices are a “tell” on housing. Housing is a “tell” on the health of the economy. If lumber prices are declining, that’s likely a good indicator that the demand for housing materials, and perhaps housing in general, is weak and could signal that the broader U.S. economy is about to be pulled down with it.
How does the lumber market look today? Pretty ugly.
Lumber prices right now are around their lowest level since 2020. After the government’s multi-trillion-dollar stimulus package was introduced during the Covid-19 recession, the housing market took off and lumber prices led the way. Thanks to significantly higher mortgage rates, high inflation and creeping recession risk, lumber has plunged back to where it was pre-Covid-19.
Does lumber successfully predict housing market declines? It’s a bit hard to say because there have been so few of them over the course of history. The only notable instance prior to 2022 where the housing market collapsed was during the financial crisis. We can see from the chart above that lumber started steadily declining as early as 2004, more than two years before national home prices started to turn south. The second instance is right now. Lumber prices hit their peak in 2021 and the Case-Shiller national home price index began falling in mid-2022.
Granted, that’s a sample size of two and lumber prices have historically been volatile, but it makes sense to think that it’s a leading indicator. Plus, we’ve got some other data to back it up in the current environment.
Does the Data Point to a Housing Market Crash?
Single-family home starts are perhaps the best indicator of the residential real estate market. This number has returned to its pre-pandemic average, but that’s also roughly 30% below where we were at the beginning of 2022. This would suggest that the demand for new homes has normalized again, but home prices are still well above where they were at that point. Is a correction needed to bring home prices back in balance too?
Let’s take one more step back earlier in the process — building permits. We have plenty of evidence already that a huge percentage of new home contracts are getting canceled and that’s showing up in the data.
There was an unexpected uptick in both starts and permits earlier this year when the general economic data, including retail sales and GDP, came in surprisingly strong. That may give the markets the impression that a rebound is happening, but I’m skeptical. Retail sales turned out to be a single-month outlier and permits moved back down quite a bit in March. I strongly suspect the slowing housing market trend isn’t over.
If the data trends are pointing to a potential crash in the housing market and lumber prices have been signaling conditions are ripe for it, equity investors could also take a beating.
The Bottom Line on Lumber Prices
Again, there’s volatility in lumber prices and not every decline is a signal, but significant equity corrections have historically been correlated with pullbacks in lumber prices. We saw it during the stagflation ‘70s, we saw it to a modest degree during the tech bubble, we really saw it during the financial crisis, and we see some evidence of it happening again today.
Lumber is perhaps the commodity most closely tied to the housing market. It’s suggesting that investors should approach this market with a high degree of caution right now.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
