WY - Weyerhaeuser: A Lumber Proxy For 2024

2024-01-04 13:37:54 ET

Summary

• Lumber prices are influenced by interest rates, which impact mortgage rates and new home construction.
• Weyerhaeuser Company is a real estate investment trust that benefits from stable to rising lumber demand.
• The new physical lumber futures contract aims to increase liquidity and reduce price volatility, but it has not achieved critical mass yet.

Lumber is an essential industrial commodity that is a critical ingredient in infrastructure building. Moreover, lumber is a crucial commodity for new home construction. Therefore, lumber prices follow interest rates that determine the mortgage rates that either support or inhibit new home construction.

The 2020 global pandemic unleashed a tidal wave of central bank liquidity and government stimulus, sending interest rates to record lows. In late 2021, a 30-year conventional fixed-rate mortgage was below 3%. When the U.S. 30-year government Treasury bond futures fell to 107-04, the lowest level since 2007, in October 2023, the mortgage rates rose to over 8%. The payment on a $400,000 mortgage rose by over $1,660 per month, causing the demand for new homes to plunge, as increasing rates excluded many potential buyers. Meanwhile, the low rates of previous years meant that homeowners with 3% or lower mortgages had no interest in selling, limiting the supply of existing homes and keeping prices at sky-high levels.

The lack of new home buyers and the tight market for existing home sales caused lumber prices to plunge. After reaching all-time highs in 2021 and a lower but significant high in 2022, falling lumber demand weighed on prices, which consolidated throughout most of 2023. However, the consolidation had a slightly bullish bias, leading to a gain in the lumber futures arena in 2024.

Weyerhaeuser Company ( WY ) operates as a real estate investment trust, or REIT, with a call option on lumber prices as the company owns and leases timberlands in the U.S. and Canada. In a September 27, 2023, Seeking Alpha article , I wrote:

Anyone who believes home demand will remain strong should consider WY as a company that will benefit from stable to rising lumber demand. Moreover, the 2.4% dividend is a bonus for those waiting for capital appreciation.

There are few choices when it comes to a lumber investment. WY is highly liquid, making it one of the most attractive proxies for the illiquid wood futures market.

WY shares were at the $31.03 level on September 27, 2023. On January 4, 2024, WY was nearly 9% higher at $33.73, and the prospects for lumber and WY remained bullish in early 2024.

Lumber prices rose in 2023

The Chicago Mercantile Exchange's continuous physical lumber futures contract closed 2022 at $496.50 per 1,000 board feet. While the price dropped to the $400 level in January 2023, it recovered and moved higher by the end of the year.

The chart shows lumber futures closed 2023, 9.5% higher at the $543.50 per 1,000 board feet level.

The new physical contract takes over - Liquidity remains problematic

In 2022, the CME rolled out the new physical lumber futures contract, replacing the highly illiquid former random-length lumber futures contract. The physical contract is smaller, with each representing 27,500 board feet. Moreover, the new contract is more flexible, with a greater range of quality and delivery locations. The CME sought to increase hedging and speculative activity as more volume and open interest reduce volatility.

Over the past years, lumber prices have experienced significant price variance because of the low volume and open interest. However, at the end of 2023, with open interest below the 8,700-contract level and daily volume averaging around 1,000 contracts, the physical contract has yet to achieve the critical mass necessary to create liquidity and reduce price volatility.

An economic soft landing is bullish for lumber prices

The latest November consumer and producer price index and PCE data showed that inflation is heading towards the Fed's 2% target rate. The FOMC left rates unchanged at the early December meeting and forecasted lower rates in 2024. Meanwhile, the U.S. benchmark 30-year Treasury Bond futures (US30Y) have been rallying since falling to the lowest level since 2007 in October 2023.

The chart shows the plunge from the March 2020 pandemic-inspired high to the October 2023 sixteen-year low. The long bond fell to 107-04 before recovering and closing the year near the 125 level.

Mortgage rates rose to over 8% at the lows, inhibiting new home purchases and building. However, lower rates over the past months, the prospects for falling rates, and a soft landing in 2024 could cause homebuyers to return to the market. With a tight market for existing homes, new construction could increase lumber requirements. Therefore, a soft landing for the economy could be very bullish for lumber prices, given the market's low liquidity.

Lumber is a boom-and-bust commodity

The lack of participation in lumber futures led the CME to roll out the physical contract. However, liquidity remains sparse, meaning bids to buy disappear when the price falls and offers to sell evaporate during rallies. The extreme price action over the past years reflects the low liquidity.

The monthly chart highlights lumber price's explosive and implosive nature over the past years. After low liquidity led to a $1,711.20 high in May 2021, as inflation was raging and interest rates were at zero percent, the price plunged to a $448 low in August 2021. Lumber prices then soared to a lower $1,477.40 high in March 2022 before falling to $352.50 in January 2023 as interest rates were exploding higher.

Lumber tends to rally in spring as construction activity and new home building increases. With lower rates on the horizon and a pent-up demand for new home building and purchases, we could see lumber prices rise over the first half of 2024.

As the physical lumber chart for May delivery shows, the price has been in a bullish trend, rising from $515 in late October to over $580 per 1,000 board feet at the end of 2023 and in early 2024. Another boom period could be on the horizon over the coming months.

WY is a REIT with a lumber call option - WY should follow lumber prices and offer liquidity

Weyerhaeuser Company's profile describes its position as one of the leading real estate timber companies:

At $33.73 per share on January 4, WY had over an over $24.8 billion market cap. WY trades an average over than 3.7 million shares daily, making it a highly liquid stock., The most recent $0.76 annual dividend translates to a 2.25% yield.

The chart shows that while WY shares tend to move higher and lower with lumber futures prices, the stock underperforms the illiquid futures on the upside, but outperforms when lumber prices plunge.

A soft landing in the U.S. economy could cause new home demand and construction to rise in 2024, increasing lumber demand and prices. Rising lumber prices are bullish for WY and other lumber-related assets. Weyerhaeuser Company stock is a liquid proxy for those seeking lumber exposure without venturing into the illiquid lumber futures arena.

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