By: Jonathan V. Bever
We are experiencing something we have never experienced before. I am referring to the easy money coming out of the Fed Reserve bank. It started in the Great Fanatical Crisis of 2008/2009 and continues today in various forms, as seen by the buildup of Treasuries on the Fed balance sheet. We believe the underlying assumption is that the Fed can beat deflation when all is said and done. The Fed hopes to spark real inflation, and inflation will shrink the debt on an absolute level. On the other hand, if our economy is faced with a massive flood of deflation, this would be the worst-case scenario. In this blog, we are going to focus primarily on lumber prices.
Lumber prices are important as it relates to inflation. For most of our readers, this inflation correlates directly with their home price or remodeling costs. We are concerned with inflation and price bubbles as it relates to boom and bust economic cycles.
Our observation: the lumber business is intelligently run. As demand for lumber slowed in February 2020, some lumber mills shut down entirely, and the mills still operating were doing so at a reduced capacity. Some mills quit taking new logs (trees just cut down). The lowered production helped to balance supply and demand, thereby stabilizing lumber prices. (If only the crude oil market would follow their lead). Coincidentally, the SARS Coronavirus hit the USA at about the same time.
To grasp the big picture, let us look at the various moving parts in the lumber industry. Understanding the lumber industry is vital as it relates to the economy, inflation, and construction industry.
First, let us look at the lumber process. A tree farm cuts down trees and sells its logs to a mill or another buyer, but usually a mill. A mill will process the logs into lumber, which are used for various projects. This lumber is sold to the wholesale market and put into the wholesale inventory waiting to be sold. This inventory might change hands more than once until it meets its destination. (The other by-product from the tree process is called hog fuel, which is made up of bark, sawdust, and wood chips).
Board Lumber Price:
Our understanding is that the construction industry has a backlog of several months, putting pressure on lumber demand and prices to support unusually high lumber prices.
As stated above, lumber processing slowed in early 2020. Then the pandemic hit and slowed global economies. However, it would have the opposite effect on the demand for lumber. The pandemic had two effects on lumber that are often emphasized: the requirement to work from home and a migration away from the city. People working from home decided to remodel and make “home sweet home” even homier and sweeter—this increased demand for lumber.
The migration away from cities meant new homes to be built in remote areas. This also increased the demand for lumber.
With conviction, people say the new trend is the new normal, and if one does not hurry and buy lumber today, they will likely pay a higher price tomorrow. In short, all the makings of a bubble are intact. Throughout our series of blogs, we have argued that the Fed cannot proactively fight inflation, resulting in price bubbles. The Fed does not dare raise the cost of capital to slow the housing market, thereby softening lumber prices. To pull liquidity away from the economy has various names such as tapering, raising rates, or quantitative tightening-all these terms have been addressed in our prior blogs. In other words, the Fed could slow down the demand for lumber by raising the cost of capital. Why don’t they? Because it could have a more adverse effect on the stock market and the overall economy.
Regarding the argument of a modified lifestyle due to coronavirus, we would agree -this is probably a new normal. The SARS bat flu is one of several SARS flu and we will likely see another SARS animal flu in our lifetime; however, we hope not.
Now let us look at three charts: Generic Lumber Prices, Wholesale Lumber Inventory, and the National Home Price NSA Index.
Generic lumber prices exceeded 1300 per approximately 1000 board feet. It was 260 at the low of 2020. Please chart:
As you would expect, the higher cost of building a home is reflected in home prices. Please see the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index:
As you can see, the current average home price far exceeds the average home price preceding the 2008/2009 financial crisis. We know of two necessary components of the crisis: easy credit and buyers willing to pay higher prices. Is history repeating itself? We shall see.
Merchant Wholesalers Inventories:
If you are like us, you were surprised to see the lumber inventory so high. We kind of expected Bugs Bunny and Porky Pig to be fighting each other for the last 2x4 in the lumber yard.
Reasons for high lumber prices are the “ratio of sales to inventory” and “seasonally adjusted” numbers. Please see link: Monthly Wholesale Trade Report for March 2021 (census.gov)
Initially, we considered the high lumber demand and high lumber prices as a possible long-term problem. Now our conviction is that lack of supply, high demand, and high lumber prices reflect what is called “transitory inflation”. We would not be surprised to see short sellers sharpening their wooden pencils and waiting for equilibrium to return. Nonetheless, we expect commodity price volatility will continue in both directions.
Lastly, there is a moratorium on foreclosures and rental evictions. Approximately one in five renters are behind on rent, and ten million are behind their mortgage payments. It seems that when bubbles do pop, there is usually a loud noise. Therefore, buy some hearing protection so that you do not become deaf, as so many have from the last housing bust.
Please see the link for more information:
Generic Lumber Prices:
Description: Random Length Lumber Futures - contract specifies 110,000 board feet (one 73 flat car) of random length 8 - 20 softwood 2 x 4s, the type used for rehabbing and construction. Individual investors favor lumber, too, due to its price-trending nature. Bloomberg
S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index:
S&P/Case-Shiller U.S. National Home Price Index tracks the value of single-family housing within the United States. The index is a composite of single-family home price indices for the nine U.S. Census divisions. For more information on the S&P/Case-Shiller Home Price Indices, see https://www.spglobal.com/spdji/en/index-family/indicators/sp-corelogic-case-shiller/sp-corelogic-case-shiller-composite/#indices
The S&P/Case-Shiller Composite of 20 Home Price Index is a value-weighted average of the 20 metro area indices. These metro areas include Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York City, San Diego, San Francisco, Washington, DC, Atlanta, Charlotte, Cleveland, Dallas, Detroit, Minneapolis, Phoenix, Portland, Seattle, and Tampa. Bloomberg
Merchant Wholesalers Inventories Lumber:
This concept tracks the level of inventories (goods acquired to resell them without further processing) held by wholesalers. Bloomberg
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