LUMBER LIQUIDATORS?

Great article here from Tom Dyson on lumber demand.  Dyson argues that lumber is a good leading indicator of potential housing woes (and thus market direction):

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.

Take the 2008 credit crisis as an example. The lumber price was the first to signal a bear market was coming. It peaked in May 2004. The Bloomberg Homebuilders Index peaked in July 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. And finally, the S&P 500 peaked in October 2007.

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This is right in line with my 2009 housing thesis of a “false dawn” in housing.  The spring selling season continues to show some tentative signs of a bottoming out in housing, but don’t be fooled.  Lumber demand is down sharply and I expect the housing market to retrench as we move into the second half of the year.

Cullen Roche

Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.

He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.