WY - Weyerhaeuser: Buying Lumber On Price Weakness

2023-09-27 21:29:56 ET

Summary

• Physical lumber futures have been trading around the $500 per 1,000 board feet level since early August 2023.
• Lumber prices have experienced a significant correction from the 2021 and 2022 highs but remain above the pre-2018 all-time peak.
• Lumber is highly sensitive to interest rates, and stable rates in 2024 could cause another rally in wood prices and benefit Weyerhaeuser Company shares.

In early June 2023, in an article on the WOOD ETF on Seeking Alpha , I pointed out that the “iShares Global Timber & Forestry ETF is a liquid ETDF that investors and traders can use to position for a recovery in the lumber futures market in 2024. On June 2, WOOD held 7.5% of its assets in Weyerhaeuser Company (WY). WY settled at $28.83 per share. Meanwhile, the nearby September physical lumber futures were at $503 per 1,000 board feet.

On September 26, November physical lumber futures were virtually unchanged at the $504 level, while WY shares at $32.71 were 13.5% higher.

Physical lumber futures have been quiet around the $500 per 1,000 board feet level

Nearby lumber prices have been trading around the $500 per 1,000 board-foot level over the past months.

While the three-month chart reflects a bearish trend of lower highs and lower lows, physical lumber prices have been trading around the $500 pivot point since early August 2023.

A significant correction from the 2021 and 2022 highs, but still above the pre-2018 all-time peak

Before 2018, lumber never traded higher than the 1993 $493.50 high.

The quarterly chart dating back to the mid-1980s shows lumber futures eclipsed the 1993 high in 2018, rising to $1,711.20 in 2021. In 2022, nearby lumber futures reached a lower $1,477.40 peak before plunging to $326.60 per 1,000 board feet in April 2023. The CME discontinued the random-length lumber futures, introducing the physical lumber contract in 2022. While the price has been far below the 2021 and 2022 highs in 2023, at just below the $500 level, they remain near the 1993 pre-2018 all-time high.

Lumber is highly sensitive to interest rates- Stable rates in 2024 could cause another rally

Lumber is a crucial ingredient in new home building, making it an industrial commodity highly sensitive to interest rates.

Since March 2022, the Fed Funds Rate has soared from zero to 5.375%. Quantitative tightening to reduce the Fed’s swollen balance sheet has pushed rates higher along the yield curve. The Fed remains committed to a hawkish monetary policy path, with crude oil prices back above the $90 per barrel level and inflation ticking higher in the last consumer and producer price index reports. This week, JP Morgan CEO Jamie Dimon said he could see the Fed Funds Rate rise to 7%. Fed Chairman Jerome Powell told markets to expect high interest rates for an extended period. The U.S. long bond futures fell to the lowest level since April 2009 on September 27. Over the past sessions, stocks and many interest rate-sensitive commodity prices turned lower while crude oil continued to climb. Crude oil is a unique case as the geopolitical landscape supports higher prices. OPEC cites Chinese economic weakness as the reason for production cuts, but the Saudis need a rising oil price to balance their domestic budget.

Moreover, Russia has used oil as an economic weapon against countries supporting Ukraine and requires higher oil prices to fund its ongoing war effort. Unsurprisingly, the energy commodity that powers the world is on its way to triple-digit pricing. Moreover, the U.S. Strategic Petroleum Reserve remains at the lowest level in four decades as the administration cannot afford to sell additional barrels to cap prices.

Meanwhile, gold, copper, other metals, and grain prices have declined. However, lumber is sitting around the $500 level despite the highest mortgage rates in years. One of the reasons is the surprisingly robust demand for new homes as existing home inventories have dramatically declined. The bottom line is homeowners with under 3% mortgages will not sell and move to new homes with current thirty-year fixed-rate conventional mortgages at the 7.50% level and rising. Renters looking to own or younger new homebuyers are now faced with higher mortgage rates and rising rents, supporting the market for new home construction.

The SPDR S&P Homebuilders ETF product ( XHB ) trend suggests the demand for new homes is significant, translating to rising lumber requirements over the coming months and years.

The chart shows XHB’s initial correction as the Fed began increasing interest rates. The ETF fell 40.8% from a record $86.61 high in December 2021 to $51.23 in June 2022. However, XHB has rallied from the late 2021 low, and at $76.14 per share on September 27, the ETF is closer to the record peak than the most recent low. Booming business for new home builders means rising lumber demand.

WY is a REIT with a call option on lumber

Lumber futures are unique. While crude oil, copper, and other industrial commodities trading on futures exchanges offer significant liquidity for investors and traders, lumber remains highly illiquid. The current number of open long and short positions in the physical lumber futures arena is under 7,500 contracts. Fewer than 1,000 contracts change hands daily. Therefore, bids to buy lumber tend to disappear during selloffs, and offers to sell evaporate when prices rally, leading to price gaps and extreme volatility. The 2021 and 2022 highs and subsequent price plunges were a function of the low liquidity. Therefore, lumber futures are not appropriate investment or trading vehicles.

Lumber futures have long been a “ roach motel, ” meaning market participants may execute buy or sell orders. However, liquidating those risk positions in a market moving contrary to expectations can cause tragic losses.

Weyerhaeuser Company is a real estate investment trust that owns and leases timberlands in the United States and Canada. Therefore, the shares tend to increase when lumber demand increases and prices rise.

WY is more liquid than lumber futures. At $31.03 per share on September 27, WY had a $22.67 billion market cap. WY trades over 3.25 million shares daily and pays shareholders 75 cents or a 2.42% dividend.

The chart shows WY’s over 230% rise from the March 2020 $13.01 pandemic-inspired low to $43.04 in early 2022 when lumber prices were soaring. The shares corrected to just above the $31 level, with lumber prices around the $500 per 1,000 board-foot level in late September 2023. WY remains closer to the 2022 high than the 2020 low despite the rising mortgage rates, and lumber prices are slightly above the pre-2018 record high of $493.50.

A Fed pause could be very bullish for wood prices and WY shares

While JP Morgan’s CEO scared the market with his 7% Fed Funds Rate forecast, mortgage rates are already above that level, and new home demand remains intact. Existing home sales will continue to weigh on inventories as few homeowners requiring mortgages to buy a new home will exchange a 3% loan for a 7.50% mortgage. While the current environment supports lumber demand, any dip in interest rates could ignite another housing boom as renters look to move into new homes over the coming months and years.

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.

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