🌲 Your Guide To Investing In Random Length Lumber, A Key Commodity Used In Many Industries
Wood itself is used in numerous industries and applications, like fuel, paper, pellets, etc. But the wood we’re talking about today is random length lumber, also known as sawn wood. As its name suggests, it’s made when logs are processed at a sawmill and cut into various sizes of lumber, hence the name random length lumber. There are also different grades of lumber, depending on whether there are any defects on the wood, like dents or chips. But again, for simplicity’s sake, we’re going to talk about financially traded lumber as a standard.
What Can It Do For You
🧺 Portfolio Diversification. As always, adding commodities to your portfolio can help diversify and lower risk. Adding random length lumber to your portfolio means owning an asset that tends to act differently to other asset classes, and even to other commodities.
💰 Profit. As you can see from the price chart below, lumber prices have skyrocketed recently (roughly a 4x multiple), certainly providing lucrative returns for those who got in early. Prior to this, prices have certainly undergone periods of swings and volatility. Like all other commodities, random length lumber prices are dictated by supply and demand, and there are a number of trends, both long term and short term, that can act as support for lumber prices. In the long term, global demand for housing is likely to increase, especially in emerging economies such as China, already the world’s biggest importer of sawn wood. Furthermore, there’s also the issue of deforestation. There is only so much land available, and many industries compete for use of that land (think livestock and farming). This can potentially cause lumber shortages. That being said, there are a number of risk factors that can put downward pressure on prices. These include government trade policies, availability of substitutes, and potential overproduction in lumber supply by mills as they catch up to meet demand.
🎢 What Caused The Recent Price Spike?
Basically, it all comes down to supply and demand, where supply just isn’t enough to meet skyrocketing demand. Roughly close to the end of February 2020, pre-pandemic times, lumber prices tumbled. Then, the pandemic hit. Initially, everyone believed that the housing industry was going to suffer, so some mills cut production, lowering supply in the market. However, because people have been confined to their homes and have stopped spending, there was a boom in DIY home projects, either in remodelling and expanding. Then, house construction projects continued, using up more lumber. At the same time, with surging COVID cases and stricter restrictions in place, fewer workers operated the mills, further cutting into production, and further causing a shortage in supply.
What Affects Lumber Prices
There are several key factors that are involved in moving the price of lumber:
- 🇺🇸🇨🇳 US & Chinese Production. Though lumber is produced globally, China and the US are two of the world’s biggest sawn wood producers, accounting for 18% & 17% respectively. Any disruptions in supply in these countries can have an impact on prices, as we’ve seen during the pandemic.
- 🇺🇸🇨🇳 US & Chinese Demand. On top of being the two biggest producers, they’re also the two biggest consumers, accounting for a whopping 27% & 21% respectively. Any changes in demand in these countries can certainly have an impact on prices.
- 🏛️Government Policy. Things like subsidies and trade policies can definitely have an impact on lumber prices. Any changes to lumber subsidies, tariffs, and/or quotas can certainly have an impact on prices as it can affect supply and demand levels.
- 🏘️ Housing Data. Since lumber is primarily used to construct new residential homes, the monthly report by the US Department of Housing & Urban Development is used as an indicator for construction activity, a snapshot of demand levels that can determine prices.
- 🔥 Deforestation & Wildfires. Deforestation and wildfires can certainly reduce the supply of lumber in the market. Loggers essentially compete with the farming and livestock industry for the land, and as the world’s population grows, not only will more houses need to be built, but more food too.
- 🔄 Substitution. Yup, lumber has competing substitutes too. Other building materials like metal, concrete, and plastics, can also be used, and demand for these can take away from lumber’s market share, especially if lumber prices are higher.
- 💵 US Dollar Strength. The benchmark for the pricing of lumber is in US dollars. A weak dollar compared to other currencies (i.e. need more dollars to buy other currencies) may incentivise foreign buyers to buy (since their currencies are worth more in dollars & so can buy more lumber) & drive up demand, increasing prices, and vice versa.
What Is It Used For?
Although wood is used in many industries and is used to create numerous products, sawn wood is mainly used in the construction industry. Other uses include furniture (like chairs, desks, tables, etc.) and flooring.
The Case Against Lumber
There are a couple of risks involved if you want to get involved with lumber. Firstly, since lumber is mainly used in construction, it’s arguably linked to the strength of the economy, which means that if the global economy is weak, consumers may not want to spend on new construction builds or DIY projects. Secondly, due to the recent high prices, suppliers may utilise this opportunity to build or reopen mills to increase production, which could lead to an oversupply in the market. The high prices are certainly unsustainable, and can potentially lower demand should this continue, which would then put downward pressure on prices, leading to a correction. Last but not least, since lumber is mainly used in construction, a weakened global economy could result in lowered demand for lumber, putting downward pressure on prices.
The Case For Lumber
Firstly, like other commodities, not only can lumber serve as a portfolio diversification tool, but it can also provide opportunities for speculation and profit, as seen from the price chart above. Overall, there are a number of trends, both long term and short term, that can certainly act as support for lumber prices. In the long term, as the world’s population increases, global demand for housing is likely to increase, especially in emerging economies such as China, already the world’s biggest importer and consumer of sawn wood. Furthermore, deforestation and natural disasters like wildfires can certainly cause supply constraints in the future. Loggers essentially compete with other industries, like farming and livestock, for the land, and with wildfires becoming more and more of a common occurrence, these issues can potentially cause lumber shortages.
Popular Ways To Invest In Lumber — Pros/Cons of Each
Here are some of the more popular ways in which you can have exposure to lumber. If you’re still confused about how any of these work, refer back to our basics newsletter for a refresher.
- Physical Lumber. You can buy and directly hold physical lumber. There’s no doubt to the ownership of these assets, and is reliable. However, you may want to consider storing in a secure storage facility, usually for a fee. Selling it may also prove to be an issue as you’ll need to identify a buyer willing to buy your lumber.
- Lumber ETFs. Unfortunately, there are no ETFs that invests in physical lumber, or provide direct exposure to lumber prices, but there are ETFs that invests in a number of companies that are in the lumber industry. Because of this, on occasion, there may be times when the actual price of lumber & the price of the ETF may differ since they don’t just track lumber prices. Regardless, they’re traded on stock exchanges, so they’re pretty easy to buy and sell. Depending on which broker you go with, you may be charged with trading commissions. ETFs also charge an expense ratio, or management fee that gets taken out of their total holdings and is then reflected on your account. Be sure to read the fine print & understand the risks and costs involved.
- Lumber Stocks. Unfortunately, there are no public companies that solely focus on producing specifically random length lumber, but there are a range of public companies that is involved in the following: owns & manages forestry land, real estate investment that operates forestry land, and/or produces & sells various lumber products. Because of this, you aren’t directly following lumber prices since there are other factors at play. As always, you may want to consider looking at the company’s annual reports (especially operational costs), portfolio of what products & assets they have, what research & development they’re currently conducting, and potential expansion plans.
- Lumber Futures Contracts. A binding agreement traded on futures exchanges between two parties where they agree to buy/sell lumber at a specified time in the future with an agreed-upon price. A standard contract deals with 110,000 board feet, or 260 cubic meters of it! These futures contracts are settled with physical delivery after the contracts have expired. Because you are using a significant amount of borrowed money, even small price changes in lumber can either lead to massive profit, or massive losses beyond what you paid for, potentially leaving you in massive debt. They are certainly high-risk and not recommended for beginners. Further, fees associated with futures trading include broker commissions, and exchange/clearing fees.
TL;DR — Is It The Right Investment For You?
As always, it depends on what your aims are. Similar to other commodities, lumber can not only be used as a portfolio diversification tool, but it can also provide decent speculative returns. Overall, with a growing world population, demand for lumber is likely to increase, especially in emerging economies such as China. Furthermore, the issues of deforestation and wildfires can ultimately cause a shortage of lumber. However, due to the recent price spike, there is a potential risk of overproduction by suppliers, which would put downward pressure on prices. On the demand side, the price spike could cause demand to lower. Last but not least, as mentioned above, since lumber is mainly used in construction, a weakened global economy could result in lowered demand for lumber.
🧺 If you are considering adding lumber to your existing portfolio or bundling it with a number of others, you may want to consider doing dollar-cost averaging (regular investments over time) to build your lumber position so you can take advantage of any volatility in the market.
💰 If you are considering adding lumber for speculation and profit, you may want to monitor the factors that affect lumber prices mentioned above. You may also want to keep track of the monthly housing reports released by the US Department of Housing & Urban Development as that can be an indicator for demand levels. In addition to monitoring the factors mentioned above, you may also want to consider performing some technical analysis on lumber’s price chart to help consolidate trends and patterns to help with your decision. That being said, its price can also swing unexpectedly and dramatically, so be prepared and have an exit plan in place.
As always, if you are unsure, check in with a professional financial advisor before making any moves.