Lumber Has Given Back Its Gains… Will The Stock Market Follow?
By Tom Dyson | 24 December 2008
Don carries a tape measure on his belt. A yellow pencil lives behind his ear. And to get from one end of his yard to the other, he drives a forklift truck… Don entered the lumber business in 1979. In his 30-year career in the lumber-distribution business, he has worked for both the huge national lumber distributors and the small regional suppliers. He's also worked through two major construction busts… in 1979-81 and 1990-91. Today, Don is general manager of a $100 million lumberyard based near Orlando, Florida.
I figure, if we're going to see evidence of inflation, it's going to show up first in building products. This was the first industry to crater back in 2005. It should be the first industry to complete the cycle.
The government thinks the falling real estate market is driving the recession and the credit crunch. If it can get the real estate market rising again, it thinks it'll be able to beat deflation and solve all our problems. Any signs of life in the real estate market will "validate" the Fed's strategy and generate a burst of optimism in the stock market.
So, the people in charge have decided that if they can "fix" the real estate market, then everything else will "fix itself". The Fed has aimed its printing press directly at the real estate market. It will buy $500 billion of mortgages using freshly created dollars. The government has focused many of its other plans on the real estate market, too… like its demand for the banks to have a temporary moratorium on foreclosures (now lapsed) and Obama's $50 billion mortgage and foreclosure rescue plan.
In other words, the U.S. real estate market is seen as the pivot in the whole economic mess we're in right now. So, if you can figure out what's happening in real estate, you can figure out everything else. And, the best leading indicator of real estate is lumber. About two thirds of American demand for lumber comes from the homebuilding and remodeling industries… so its price is highly sensitive to strength and weakness in construction.
Every month, Don tells me what he thinks is going on in the industry and updates me on the prices of lumber, sheet wall, concrete sidings, and other building products. These prices come straight from the manufacturers. Prices peaked in October 2005. Since then, many materials have fallen in price over 50%. I just got Don's latest e-mail last week. It's shocking how prices have jumped…
- Plywood rose 9.9%.
- Pine lumber was up 5.8% to 15.7%.
- Most metal connectors were up 5% to 20%.
- Truss prices fell only 2.9%, but the strength in pine will push those prices upward in January.
- Molding prices were up 12.5% to 13.6%. Door prices were mixed.
- Concrete siding was up 9.4%, and vinyl trims were up 4.8%.
- Vinyl siding trim was up 14.5% with a reduction of manufacturers.
(Some prices declined, too. Roll foundation plastic fell 6.7%, rebar dropped 3.4%, spruce lumber gave up 15%, studs fell 10%, and drywall products all fell between 6.7% and 9%.
Don creates a Whole House Commodity Price Index with this information. It's the price of materials to build a 2,250 square-foot wood-frame house. It doesn't include labor, decor, plumbing, electrical, or mechanical materials. In November, Don's Whole House Commodity Index was up 1% percent, to $23,773. "Every major supplier in drywall, roofing, insulation, insulation board, steel studs, cement board, and most of the miscellaneous building material categories have announced increases in cost from 7%-10%," says Don.
It's still too early to make conclusions from Don's pricing data (which should be used to confirm the earlier trend in lumber prices). I suspect many companies realize they'll go out of business if they keep selling their products at a loss. So they've raised their prices out of desperation. In other words, these price increases aren't necessarily a reflection of increased demand— they're a sign of capitulation in the building materials industry… and we're about to see some major bankruptcies.
Let's give Don's building prices three more months. If they stick, it's a sign the Fed's strategy just might be starting to work. And that should mark a bottom for stocks. [[Note: That would have been March, 2009! : normxxx]] But, if building prices don't continue rising, we'll be in for more deflation.
Good investing,
Tom
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The World's Most Important Commodity
By Tom Dyson | 18 February 2009
By watching the price of Don's Whole House Commodity Price Index for home building materials, you'll know when the recession is ending… before anyone else. You'll know if Obama's stimulus plan is having any effect. You'll know when the construction industry is about to start hiring again or when the banks are about to start lending again. And you'll be able to tell your neighbors when house prices are going to rise again.
Around the office, we say copper has a PhD in economics because it predicts recessions and booms. We call it "Dr. Copper." But Don's Index is a much more valuable indicator for right now, and no one's paying attention to it. Let me explain.
Take the timeline of the current crisis as an example. The lumber price reacted before any other market: Lumber prices peaked in May 2004. The Bloomberg Homebuilders Index didn't peak until July 2005. Don's Index peaked in October 2005. The Case-Shiller U.S. home price index peaked in July 2006. The credit crunch started in February 2007, when New Century Financial collapsed. The S&P 500 peaked in October 2007. [[And, finally, the complete collapse of the credit market occured when Lehman Bros. filed for bankruptcy on 15 September 2008. : normxxx]]
When the recovery comes, I expect it'll show up first in the lumber price, too… Right now, lumber is down 66% from its 2004 all-time high. A standard railcar load of lumber sells for $17,050— the same price it was selling for in 1973. Looking at the monthly chart, there's still no sign of an uptrend… but I can report the lumber price has risen 12% in the last three weeks, up from 1969 prices.
The lumber price holds the key for investors right now. Make sure you keep an eye on it.
Good investing,
Tom
P.S. You can get this chart of lumber prices on StockCharts. Just type in the symbol $LUMBER.
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This Indicator Says Home Prices Are Nearing A Bottom
By Tom Dyson | 6 April 2009
I ride my bike to work, always taking the same route. I pass the same 100 or so houses every day. This week, I noticed two new properties have come on the market. One of these houses is on the beach. The owner has posted a large billboard on the curb. "Foreclosure Sale," it announces. "Online Auction."
Every week I see new for-sale signs along my route. This is the first auction notice I've seen. And although it's an ugly, worn-out old house, it's on prime beachfront property. Most Americans gauge real estate using the same process I use on my bike. They talk to their neighbors, they notice for-sale postings along their street, and they watch local news reports.
From this "bicycle-seat view," it appears to the average American that the bear market in real estate in still in full swing and getting worse by the week. Here's the thing: Trying to predict trends in the real estate market by watching house prices is like trying to predict the stock market by watching CNBC. It doesn't work.
Houses are illiquid assets. It can take months for homeowners to accept their houses have fallen in value and lower their prices appropriately. Many potential sellers have mortgages larger than the value of their homes. They can't sell. Banks have it even worse. It takes an average 15 months for a bank to sell a property after the first missed mortgage payment. Many foreclosures haven't hit the market yet.
House prices are what economists would call a "lagging indicator". [[Actually, changes in local housing inventory are a good inverse precursor of changes in housing prices.: normxxx]] They are slow to react to new trends in the market. For forecasting purposes, they are useless.
To judge what's really going on in real estate, you need a leading indicator, such as the price of lumber. The lumber market is a small, illiquid market, so it's sensitive to any changes in supply and demand. In the last cycle, for example, lumber prices peaked in May 2004… two years ahead of house prices. If house prices are going to turn up, you'll see it first in the lumber price… and that's what's happening right now.
In the last three weeks, the lumber price has soared 29%… after making a "quadruple bottom" at $140 a contract. Last week, it broke out to a new high for the year. This is incredible strength in a market you'd think would be dying. But, if this trend withers, expect lower house prices ahead… On the other hand, if it continues, expect a bottom in home prices within the next 18 months.
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This Indicator Holds the Key for Investors
By Tom Dyson | 15 May 2009
To predict the stock market, I watch lumber. To store lumber, you need a large climate-controlled warehouse with a railroad spur. Even then, it could still spoil within six months, destroying your entire investment. Because lumber loses its value quickly and it's expensive to store, the investment public at large does not participate in the lumber market. The costs are too high.
The mills use "just-in-time" manufacturing principles to keep inventories to the bare minimum. By producing only what they can sell immediately, they avoid wastage. Lumber customers do the same thing. They only buy what they need that week.
There is a lumber exchange in Chicago where you can trade lumber futures. It's a "professionals only" industrial matchmaking service. If you're a homebuilder and you need lumber for a current construction project, the lumber exchange works fine for you. But if you're an investor looking to hold lumber for a year or more, you'll get ripped off.
First, you'll pay huge storage costs. The market builds these costs into the futures price. Second, there's almost zero trading volume once you get beyond the next three months, so you'll pay a massive premium for illiquidity. For example, right now, if you want to buy lumber into the future— say a contract that expires one year from now— you'll have to pay a 38% premium over the price of lumber delivered next week.
These costs keep the riff-raff out of the market. This is why I love to watch lumber. The price of lumber is set entirely by commercial money responding to real business conditions. There's no public speculation to muddy the water and generate confusing signals.
Take the 2008 credit crisis as an example. The lumber price was the first to signal a bear market was coming, in May 2004. Here's a chart of lumber going back three years. As you can see, lumber bounced like everything else earlier this year, but has not been able to hold its gains.
I take this as a message from the homebuilders and the giant logging companies that the real estate market is getting worse again. And if that's the case, it might be time for stocks to take a breather, too.
Good investing,
Tom
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