Client Portals

Why The Lumber Chart Has Gone Parabolic4 min read

May 5, 2021 - Max Osbon ( 5 mins to read)

The lumber futures chart has been one of the most interesting economic price charts to watch over the past year. Lumber prices in the futures market are based on random length construction boards like 2x4s. Since 1978, the price has bounced between $200 and $400, with a brief all-time high of $600 in 2018. However, over the past year, the price has exploded to the upside rising from $300 to $1600 in just 12 months. It’s a rare economic moment that deserves a closer look.

This is a chart of the front-month lumber contract price going back to 1978. 

Unprecedented demand during a shutdown

The onset of the pandemic created a massive increase in lumber demand. People stuck at home came to realize that their home wasn’t exactly what they wanted. Within a short window, consumers dramatically increased their buying, building and remodeling activities at massive scale. At the same time, our sawmills shut down during the worst months of COVID last year. With the increase in demand during a shutdown period, sawmill production is far behind schedule.

The supply side is reacting quickly. Billions of dollars have been recently invested into building new sawmills in the South where we grow a significant amount of our timber supply. Those sawmills are aiming at increasing total lumber capacity by approximately 25%. When you look at the chart above, you might wonder if we are running out of trees to support lumber production. Fortunately, that’s not the case at all. There is a tremendous supply of trees in the southeast of the US and the prices of timber have not moved at all.

We have plenty of timber

Timber has been advertised as a steady investment opportunity for decades. In the 1980s the US government had a program where they paid farmers to convert their land into tree growing. The thesis for investing in timber is simple: it requires significantly less maintenance than farming and the trees grow every year regardless of the performance of the stock market. This thesis became so popular that Harvard’s endowment at one point had a professional timber investment team. However, due to the popularity of the opportunity, oversupply has led to mediocre returns.

Sawmills control the price

Over the past 12 years, sawmill businesses have consolidated their pricing power by buying up and combining existing players. They’ve also added new sensors and automation to their systems, turning them into highly sophisticated operations. Despite the billions being invested into sawmill facilities in the south, it will take roughly 12 months to have those facilities running at full capacity. Sawmill employment has taken a hit due to government assistance programs and it may take some time to find enough labor to run the mills. Until the new sawmills are at full capacity, the price of lumber is likely to stay at the higher range.

A 75% drop from here is likely

Over time the price of the timber (logs) and the price lumber (boards) will converge. We have no shortage of trees, so it’s just a matter of how long it takes to convert our supply into lumber to meet the increased demand. If you have the flexibility to wait on buying the lumber, know that the price isn’t going to remain at this new level forever.

One new revenue source for timber farmers today is the carbon credit market. Net carbon producers, like manufacturers or oil companies, can purchase carbon credits as a way to offset the environmental impact of the business. Already, timber farmers have collected hundreds of millions in carbon credits to postpone cutting their trees down for another year. Perhaps the carbon credit market will start to eat into the available supply of trees, but that seems like a long way off.

It’s difficult to profit from this coming price drop. The futures contracts for lumber prices at future dates are all trending down (this is called backwardation). You can’t expect to profit from shorting the lumber prices when the future prices are already predicted to be substantially lower than they are today. While we wouldn’t recommend that you short the lumber futures market, you can at least gain confidence that the sticker shock of these astronomical lumber prices won’t last.

WEEKLY INSIGHTS
delivered to your inbox

DISCLAIMER

This communication may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.”

“Historical performance is not indicative of future results. The investment return will fluctuate with market conditions.

Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.

Investment strategies, philosophies, allocations and holdings are subject to change without prior notice.

This communication is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.

While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.

Adviser does not endorse the statements, services or performance of any third-party vendor.

Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.

Any IPO alerts are purely informational and should not be construed as recommendations to invest.

Adviser is not licensed to provide and does not provide legal, tax or accounting advice to clients. Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.

Any case studies or hypothetical client profiles are for demonstration purposes only. They illustrate the breadth and depth of the many clients we represent at various life stages. Any similarities to actual Adviser’s clients past or present are strictly coincidental. Individual advice and results will vary based on each client’s circumstances, objectives and prevailing economic conditions.