A Bounce In Lumber- Weyerhaeuser Shares Remain Near The Lows
- •Lumber recovers from the April low.
- •Weyerhaeuser shares tanked.
- •Lumber is untradeable in the futures market.
- •WY is a commodity-based REIT.
- •Low interest rates, the potential for an infrastructure program in the US, and the lowest level in years supports medium to long-term gains in WY shares.
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Lumber is a critical industrial commodity when it comes to construction. The lumber futures market can be highly volatile. The price of wood futures has traded in a range from $214.40 to $659 per 1,000 board feet since September 2015. The lumber market is particularly sensitive to the homebuilding market. The global financial crisis in 2008 pushed the price of wood futures to a low of $137.90 in early 2009. In the United States, the meltdown in the housing market and mortgage-backed securities market caused the demand for new homes to plunge.
In March 2020, the global pandemic that weighed on markets across all asset classes caused a deflationary spiral that sent the prices of many raw materials appreciably lower. While lumber futures declined, they reached a low of $251.50 per 1,000 board feet, significantly higher than during the 2008 debacle. Lumber futures are illiquid. While I have trades almost all commodity futures during my career, I never bought or sold one contract of lumber. Meanwhile, I watch the price like a hawk as the price of wood is a crucial indicator of industrial commodity demand and a barometer for the housing market. When it comes to taking advantage of opportunities in the lumber market, I like to use proxies. Weyerhaeuser Company (NYSE:WY) is unique as it operates as a real estate investment trust. The company owns and leases timberlands, which provides exposure to the price of lumber. I last wrote about WY on Seeking Alpha in late February, but the markets have changed dramatically since then as the global pandemic spread around the globe like wildfire.
Lumber recovers from the April low
The volatile lumber futures market rose to $659 in May 2018 and fell to a low of $286.10 in May 2019. As the stock market rose in the US and the Fed began cutting interest rates last July, lumber worked its way higher, reaching a peak at $468.30 in February 2020 when Coronavirus started spreading around the globe.
The weekly chart highlights that lumber declined in sympathy with markets across all asset classes as economies came to a sudden halt because of the global pandemic. Lumber fell to a low of $251.50 during the week of March 30. After short-term interest rates in the US fell to zero percent and the Fed began injecting unprecedented levels of liquidity into the economy, the price of wood began to rebound, reaching its most recent high of $349.10 per 1,000 board feet in mid-April. On May 5, the price of the nearby futures contract was below the $340 level, closer to the recent high than low at just over $250.
Weyerhaeuser shares tanked
Weyerhaeuser Company (WY) shares tend to follow the price of lumber futures. The stock is not as volatile as the futures, but the direction tends to display a correlation.
WY shares reached a peak of $38.39 per share in June 2018 just after lumber rose to its all-time high of $659 per 1,000 board feet. The shares then fell to a low of $22.35 in May 2019 when lumber reached $286.10. WY shares are also sensitive to the overall stock market. The low of $20.52 in December 2018 came as a result of the selling in the equity arena during the final quarter of 2018.
The deflationary spiral caused by Coronavirus sent lumber to its most recent bottom at just over $250 per 1,000 board feet while WY shares fell to a low of $13.10 per share in late March of this year.
At $13.10 per share, March 23, 2020, represented was the lowest price for Weyerhaeuser stock in thirty-eight years since 1982.
Lumber recovered to around the $330 level on May 5, and WY shares were trading at $18.00 per share.
Lumber is untradeable in the futures market
The liquidity in the lumber futures market makes it a challenging commodity when it comes to trading or investing.
The quarterly chart illustrates that the total number of open long and short positions in the lumber futures market rose to an all-time high at over 14,400 contracts in 2008. At 2,732 contracts on May 4, the open interest metric is under 20% of the all-time high. At the same time, the trend in open interest has been lower over the past twelve years.
The metric in the other leading industrial commodities, copper and lumber, has been rising over the period with the latest level of open interest at over 160,000 and 2.23 million contracts, respectively. Fewer than 500 lumber contracts change hands on an average day, making the wood futures contract illiquid. Commodity traders call markets like lumber “roach motels” as market participants can get into long or short positions, but they cannot get out of the risk position without a considerable financial cost.
Meanwhile, there are times when lumber presents a compelling opportunity when it comes to a trade or investment position. During these periods, I have found that WY shares are a better and far more liquid choice.
WY is a commodity-based REIT
Weyerhaeuser shares are liquid, with an average daily trading volume of around 5.9 million. The company had a market cap of $13.45 billion at a share price of around $18 per share.
WY is one of the world’s largest private owners of timberlands with ownership of control of around eleven million acres in the United States and addition properties under long-term lease in Canada. The company has been in business for 120 years as it began operations in 1900. In 2019, WY generated $6.6 billion in net sales and employed approximately 9,400 people around the world. Aside from operating as a real estate investment trust, WY is one of the leading manufacturers of wood products in the US.
In Q1 2020, WY beat EPS forecasts by five cents per share when it reported earnings of 18 cents.
Source: Yahoo Finance
As the chart shows, the current forecast for Q2 is for earnings of two cents, but that could be a challenge in the current environment as the economy remains in a self-induced coma. At $18 per share, WY was paying shareholders a 6.22% dividend, which could be in jeopardy given the current market conditions.
Low interest rates, the potential for an infrastructure program in the US, and the lowest level in years supports medium to long-term gains in WY shares
At $18 per share, I favor a scale-down approach to buying WY shares to add to positions or establish new ones. At just over $13 per share in March, the stock dropped to its lowest price in almost four decades.
Moreover, the current low level of interest rates in the US is not a short-term phenomenon. In the aftermath of the Coronavirus, the US and the rest of the world will need to dig out of a deep financial hole. GDP in the US contracted by 4.8% in Q1, and JP Morgan analysts have said that GDP could be 40% lower in Q2. At the same time, over thirty million first-time claims for unemployment benefits since mid-March are likely to continue climbing. Double-digit unemployment will cause low interest rates and quantitative easing programs to remain in place long after there is an effective treatment for the virus that stops the fatalities.
Eventually, as the economy begins to recover, the low level of interest rates should support a return of homebuilding. However, the most promising prospects for lumber could come from government programs. The US will need a New Deal-type initiative to deal with the rate of unemployment. There is bipartisan support for a massive infrastructure rebuilding program that would supply jobs to rebuild the crumbling roads, bridges, tunnels, airports, and other parts of the US infrastructure. An enormous construction initiative would require lots of lumber, which is supportive of both the price of the wood futures and Weyerhaeuser shares.
While we could see another wave of selling in the stock market that takes WY back towards the March low or lower, a scale-down approach to the shares could be the optimal approach to this lumber-based REIT. WY has been around for 120 years, and the company is likely to survive Coronavirus and the current economic travails.
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Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.Over the past two decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities.
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