Lumber Prices May Burn Real Estate Bears

The effect of lumber prices on real estate is undeniable. As such, lumber prices can be used as a forward-looking indicator for the housing sector. Right now, lumber is carving out a potential inverse head-and shoulders bounce that may burn real estate bears.

What do lumber prices have to do with real estate?

A whole lot more than most investors think.

In fact, the correlation between lumber and real estate is one of the least known, but most accurate forward-looking real estate indicators.

I know this sounds a bit obscure, but you can’t argue with the charts. The long-term correlation chart between lumber and the PHLX Housing Sector Index is available here. Is the Housing and Real Estate Recovery here to Stay?

The key point to keep in mind is that lumber prices lead real estate prices by about 14 months.

With that in mind, let’s look at the lumber chart.

  • Lumber formed a potential head-and shoulders bottom with the (green) neckline around 340.
  • Lumber pushed above the HS neckline and the red trend line resistance.
  • Measured HS target is around 395
  • As long as trade remains above 340, the HS target remains active

Such a rally (assuming it materializes) should be felt in the housing market about 14 months later.

Of course a relapse below 340 would hint at a failed HS breakout and further weakness, which should translate into softer home prices … 14 months later.

Some of you may still wonder if lumber prices are really a ‘legit’ indicator.

Almost exactly a year ago (August 27), we published a lumber chart with a 14-month outlook via this article: How to Turn the Lagging S&P/Case-Shiller Home Index into a Leading Indicator

With the benefit of hindsight, we can now check if lumbers message a year ago proved correct.

Below is the original August 27 chart. The green graph represents lumber prices set forward by 14 months. The blue graph reflects the actual performance of the PHLX Housing Sector.

Major ‘pops and drops’ in lumber prices (such as in 2013) tend to show up muted in the real estate market – which is what happened again over the past 14 months – but directionally real estate continues to follow the beat of lumber.

Simon Maierhofer is the publisher of the Profit Radar ReportThe Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

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Weekly ETF SPY: Lumber Prices and Lumber Related ETFs

At first glance you probably won’t be interested in lumber and lumber prices. But, you should know that lumber prices have a good track record of foretelling what’s next for the real estate market. According to lumber prices, the real estate market is in for a roller coaster ride.

Back in October 2012, March 2013, and May 2013 we used lumber prices as a leading indicator for real estate prices (article listed below):

How to Turn the S&P/Case-Shiller Home Price Index into a Forward-Looking Indicator

Leading Indicator Projects Still Higher Real Estate Prices

Is the Housing and Real Estate Recovery Here to Stay?

Using lumber as a forward-looking indicator for the real estate sector has proven quite accurate, so it makes sense to look at what lumber prices are up to now.

Earlier this year lumber futures soared to $411.50 for on-track mill delivery of 110,000 board feet of random length 8-foot to 20-foot 2×4 inch pieces.

March 14, 2013 marked a significant peak and prices have fallen as much as 32.8%.

As outlined by the above-mentioned articles, lumber prices precede real estate prices by 12 – 15 months. In other words, forwarding lumber prices by 12 – 15 months allows us to roughly gauge what’s next for real estate.

Based on this observation (click here for a side-by-side comparison of lumber and real estate prices), real estate prices have a rocky road ahead (see chart below).

What’s next for lumber prices?

The chart below shows that there was no bullish RSI divergence at the most recent low. This suggests that the current rally is a counter trend.

Resistance is provided by the red lines. Prices are already above the two lower lines so a deeper retracement of the recent decline is possible.

It appears that ultimately lower prices are ahead for lumber, which will eventually (with a 12 – 15 month lag) be bad news for real estate.

There are two lumber-related ETFs:

iShares S&P Global Timber & Forestry Index Fund (WOOD)
Guggenheim Timber Index ETF (CUT)

Neither CUT nor WOOD track the actual price of lumber, but follow indexes composed of timber companies or firms that are in the timber trade.

Leading Indicator Projects Still Higher Real Estate Prices

According to some measure, real estate prices just recorded their biggest annual gain since 2006 and surveys show that Americans’ confidence in real estate is growing. Contrarians may consider this to be bearish, but one leading indicator doesn’t.

The S&P/Case-Shiller Home Price Index has become an important gauge of the real estate market. Index levels are updated on the last Tuesday of every month (that was yesterday).

The January data (the index uses a 3-month average and is published with a 2-month lag) showed a 0.1% month-over-month and an 8.1% year-over-year increase for the 20-city composite. The YOY figure was the biggest jump since the summer of 2006.

Compared to what we’ve gotten used to, this sounds grandiose. The first chart below puts last year’s gain into perspective. Although it looks less earth shattering, the increase is respectable.

Forward-looking investment decisions aren’t based on rearview mirror-focused analysis, so what’s next for the real estate sector?

Quirky but Credible Leading Indicator

In the October article “Is the Real Estate Recovery Here to Stay?” I introduced a quirky but credible leading indicator for real estate prices – lumber prices.

Lumber is a key component for every house, therefore seeing the connection between the raw material (lumber) and finished product (house) isn’t much of a stretch.

The October article plotted lumber prices set forward by one year against the PHLX Housing Sector Index and highlighted the correlation between major tops and bottoms (something we won’t do today).

 

Our conclusion, based on the leading lumber prices indicator, was that the housing recovery would last at least into mid-2013.

Why 2013? Because lumber broke through trend line support. At the time we didn’t know if this would end the lumber rally or not.

Today we know that lumber prices recovered and soared on to new recovery highs.

The October article noted that the correlation between lumber and real estate prices might be even better if lumber prices are set forward by more than 12 months. The chart below does just that. It plots the PHLX Housing Sector Index against lumber prices set forward by 14 months.

Obviously, the strong rally in lumber prices bodes well for real estate prices and real estate ETFs like the iShares Dow Jones US Real Estate ETF (IYR) or Vanguard REIT ETF (VNQ).

This indicator allows us to peek ahead a year or so and no further. The lumber rally has slowed as of late and various resistance levels (dashed red lines) are not far away.

It is possible that the real estate rally will run out of steam in mid-2014. If that’s the case, lumber prices will be our canary in the mine.