Lumber - Will Falling Interest Rates Lift The Price Of Wood?

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About: iShares S&P Global Timber & Forestry Index ETF (WOOD), Includes: BCX, CTT, CUT, GNR, GRES, GUNR, HAP, MXI, WY
by: Andrew Hecht
Summary

Lumber goes from king to pauper.

Longs get splinters.

The Fed is likely to provide fuel for lumber prices.

Levels to watch in the illiquid futures market.

WOOD, CTT, WY - pick a piece of investment timber that could ignite your portfolio.

The lumber futures market is highly illiquid with only 4428 contracts of open interest. However, lumber is a critical raw material when it comes to construction. I view the price action in the lumber futures market as one of the leading benchmarks when it comes to the overall health of the US and global economies. I often watch lumber, copper, and crude oil prices for clues about economic conditions. The crude oil futures market has an open interest of over 2.06 million contracts, while copper futures on COMEX have almost 283,000 contracts of open long and short positions. The participation in the lumber market pales in comparison, but at times, the price of wood can be a leading indicator when it comes to economic growth or contraction. While I trade in the crude oil and copper futures arena, I avoid lumber like the plague. Since the early 1980s, I never traded even one contract of lumber, even though I watch the price action every day.

Three market products follow the price of lumber and are liquid when it comes to long or short positions. Shares of Weyerhaeuser Company (WY), the iShares Global Timber and Forestry ETF (WOOD), and the CatchMark Timber Trust, Inc. (CTT), all move higher and lower with the price of lumber futures and serve as proxies.

Lumber goes from king to pauper

The price of lumber futures hit a low at $214.40 per 1,000 board feet in September 2015. In late 2015 and early 2016, most commodities prices found bottoms.

Source: CQG

As the monthly chart highlights, the price of lumber futures climbed steadily through the end of 2015 and throughout 2016 and 2016 and the first five months of 2018. In late 2017, the price of wood moved to a new all-time high, surpassing the previous peak from 1993 at $493.50 per 1,000 board feel as it reached the $500 level. In 2018, wood blew away that level reaching $659 per 1,000 board feet during the week of May 14. Low interest rates and economic growth in the US supported the demand for lumber. At the same time, concerns over trade negotiations with Canada and the replacement of NAFTA with the now USMCA agreement led to the peak price for wood. However, as the Fed became more hawkish and added am additional interest rate hike last year in June, the prospects for rising rates weighed on the lumber market like a ton of bricks. By October, the price more than halved in value and probed below the $300 level for the first time since 2016. Lumber went from the king of the commodities market to a pauper.

Longs get splinters

The weekly chart shows that the price stopped falling at $299.90 per 1,000 board feet during the week of October 22, 2018, and a recovery took wood futures back to over $450 in early February. However, the recovery rally failed, and the price deteriorated. In late May, the price fell to a lower low, taking out the October bottom.

Source: CQG

The daily chart illustrates that the lumber futures market suffered a spike to the downside on May 29 when the price fell to $286.10 per 1,000 board feet. However, on that very day, lumber bounced and closed the session at $316.20. Since then, the price has been making higher highs and was at the $343 level on June 11 on the nearby July futures contract. Price momentum and relative strength indicators are rising on the daily chart, while on the weekly and monthly pictorials both metrics remain in oversold territory. A period of price consolidation could be healthy for the lumber market as the Fed has reversed course from its approach to monetary policy last year at this time.

The Fed is likely to provide fuel for lumber prices

The Trump administration has not been happy with the Federal Reserve, even though the President nominated Jerome Powell as the Chairman succeeding Janet Yellen. After hiking the Fed Funds rate four times in 2018 to 2.25-2.50%, the President and members of his administration called for the central bank to lower rates by 50 basis points. On June 10, President Trump said that the Fed has been "destructive" when it comes to both economic growth in the US, and the ongoing trade dispute with China. Higher rates support the value of the dollar, which makes US exports less competitive in global markets giving China the upper hands as they devalue their currency, the yuan.

Meanwhile, the trade dispute and signs that the US economy is weakening have softened the hawkish Fed who earlier this year canceled any rate hikes for 2019. The latest statements out of Fed officials have been supportive of a rate cut in 2019. As of last Friday, Eurodollar futures were projecting a 60% probability of two rate cuts totaling 50 basis points by the end of 2019, and some analysts are projecting the Fed will act three times for a total of 75 basis points this year. We will not have to wait long to hear from the Fed as the next FOMC meeting is next week on June 18-19.

Lower short-term rates will follow the action in the longer maturities as the 30-Year US Treasury bond has exploded to the upside since last October.

Source: CQG

The weekly chart of the 30-Year Treasury bond futures contract shows that the long bond rose from a low at 136-16 in October 2018 to its most recent high at 155-22 earlier this month. At the 154 level, the long bond remains near the recent high. Higher bonds and lower interest rates add up to lower mortgage rates, which are supportive of demand for new homes in the US. As 30-year fixed rate mortgage rates have slipped below the 4% level, the demand for new homes translates to rising lumber requirements. At the $340 per 1,000 board feet, which is $56.90 above the recent low, and $319 below the 2018 peak, the risk-reward for lumber could be compelling if demand will rise in the coming months because of falling interest rates.

Levels to watch in the illiquid futures market

Support for lumber futures is at $300 and the recent low at $286.10 per 1,000 board feet.

Source: CQG

As the daily chart shows, the first level of technical resistance stood at the $330 level, and above there, at $366.50, which was the May 13 peak. On the upside, the $383.10, $411.90, and 431.80 levels all stand as resistance levels. The critical price on the upside is at the 2019 high at $453.90 per 1,000 board feet from early February. In the move to the upside on June 11, lumber left a gap from $325 to $330.20 which price action may need to fill.

Lumber can be a highly volatile commodity, and those who got splinters from long positions in May could find long positions in the wood market catching fire later over the coming weeks and months with interest rates moving lower.

WOOD, CTT, WY - pick a piece of investment timber that could ignite your portfolio

I would never recommend any risk position in the lumber futures market given the lack of liquidity because of the low open interest and daily volume, which makes execution more than a challenge. However, the three products I favor that have reasonable correlations with the price of wood are shares of Weyerhaeuser Company, the iShares Global Timber and Forestry ETF, and the CatchMark Timber Trust, Inc. Lumber rose from $214.40 in September 2015 to a high at $659 in May 2018, a rise of just over 207%. The price then fell to a low at $286.10 on May 29, or 56.6% from the peak one year earlier. During around the same periods, WY, WOOD, and CTT all correlated well with the price of lumber futures.

Source: Barchart

WY shares rose from a low at $22.06 in early 2016 to a high at $38.39 in May 2018 or 74%. The shares then fell to a low at $20.52 last December or 46.5%. While lumber fell to a lower low in May, WY shares did not challenge the late 2018 low as they reached a bottom at $23.21 in late May. WY operates as a REIT in the lumber market, is a highly liquid stock with over 4.7 million shares changing hands each day and pays its shareholders a juicy 5.96% dividend at $24.35 per share on June 11. WY owns or leases properties in the US and Canada.

Source: Barchart

The WOOD EFT product rose from a low at $38.89 in early 2016 to a high at $83.88 per share last June, a rise of 115.7%. WOOD then fell to a low at $54.33 in late May 2019 or 35.2% below its high. WOOD trades an average of 28,501 shares each day. As an ETF, WOOD's top holdings include:

Source: Yahoo Finance

WOOD holds WY shares as well as other leading lumber-related companies. WOOD's holdings yield 2.93% at the current share price at $58.08. The ETF charges an expense ratio of 0.47%.

Source: Barchart

Finally, CTT spiked to a low at $7.90 per share in August 2015 and rose to a high at $13.73 in March 2018, a rise of 73.8%. The drop that took shares of CTT to a low at $6.71 late last year was 51.1% below its high. Like WY, CTT operates as a REIT in the lumber market with timberlands in Alabama, Florida, Georgia, North Carolina, Oregon, South Carolina, Tennessee, and Texas. CTT trades an average of 214,226 shares each day and pays a 5.4% dividend at its current share price at $9.81 on June 11.

When it comes to tracking the price of lumber futures, the WOOD ETF has done the best job on a historical basis, but both WY and CTT pay attractive dividends to shareholders. If the Fed is going to start cutting rates and it lights a fire under the price of wood, and any of the three products should reflect the price action in the dangerous and illiquid lumber futures market.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

The author is trading WOOD, WY, and CTT from the long side