What’s going on with lumber?
Over the past couple of months lumber has become the unusual topic of main stream conversation. If you were to look at this years lumber price graph with no context you might confuse it with bitcoin or some hyper-growth stock. Because the price has gone absolutely parabolic over the last six months.
Soaring lumber prices add more than $36,000 to the price of a new home. -NAHB
Commodities play a major role in our economy and commerce. Like most assets, the price is ultimately determined by supply and demand. Our booming economy has lead to significant increase in demand of materials, while the the mills supplying this lumber did not anticipate or prepare inventories sufficiently prior to meet current needs. We are seeing the results of this supply/demand in-balance play out in real time. Prices have been going limit up week after week on futures exchange.
The supply chain is tight, particularly regarding the cost and availability of building materials. This is a fragmented, labor intensive, transportation operation to get the final product to job site from initial logging forestry phase of production. It’s not as easy as flipping a switch to get them all back on.
If you look at the historical price data of lumber for years, the price of 1,000 board feet of lumber has generally traded in the $200 to $400 range. It’s now well above $1,000. Well over triple the price of it’s 10-year average. A commodity that is so intricately tied to broad economic functions should not be this volatile. The ripple effect of this will be felt. As we look closer into what's going on, it seems as though the entire supply chain is braking down. Is lumber a leading indicator for broader economy?
To give an idea of how important the economic impact of home building is:
Building 1,000 average single-family homes creates 2,000 full time jobs and generates $110 million in taxes and fees for all levels of government to support police, firefighters, and schools. -NAHB
So what’s the real cause here? Corona Virus seems like the easiest reason to point the finger at. But is it fully to blame for crashing the supply chain logistics? Yes and no. When you close down the working economy it has real life consequences. When the virus hit hard, many mills and distribution vendors had to shut down for a few weeks. Trucking and rail workers getting sick slowed transportation. There were delays or shut downs all over. All of this compounding the slow of production. All the while demand is heating up, interests rates are hitting all time lows. People are buying houses like crazy. With all the new work from home mandates many people saw this as an opportunity to move or buy a second home.
Most states deemed building industry as essential so the demand side never received the pause we saw on the supply side. Now pair this with hurricanes hitting the east coast, midwest freezing over, and fires through out Canada. On top of resin supply shortages to make the wood materials. Labor force shortages. The production mills have gone through the ringer and it is hard not to think they aren’t somewhat using this to their advantage trying to capitalize on these ridiculous price levels. There’s a multitude of reason’s stacked on top of each other affecting the supply side. We start to realize once one cog in the gear goes down, just how interconnected everything is. I’d point out demand is the driver of these sky high prices right now and the is the best way to fix things. If you want lumber prices to come down, just stop buying lumber.
Unfortunately it’s never that simple. And builders are forced to buy right now at these levels. This all wouldn’t be as big of a deal if we had current houses for sale in the market inventory. Looking at the FRED economic data, the monthly supply of houses in the US is nearly at all time lows. Meaning houses need to be built. The demand is red hot on a national level.
The US housing market is 4 million homes short of buyer demand.
Let that sink in.
Even with inventory at the lows, supply side has room to run. We are back to levels not seen since before the 08' crash, but not to unsustainably high levels. The subprime mortgage crisis upended home building capacity and left a major scar on the industry. We are largely still feeling those pains. It’s partly the underpinning of our current housing shortage. Even before covid the market could have absorbed more building, but the surviving firms are very conservative in their approaches now. Which might explain why they haven’t done more to seize demand earlier on.
One of the main driver of the recent housing boom can be thanked to the low interest rate environment the Fed has created. When you can lock in a 30yr fixed mortgage for under 3% everyone wants to take advantage of this generous lending. As they should be incentivized to. From a historical standpoint it’s hard not to want to get in on the action. A decision to raise rates would certainly dampen demand. But as the Fed has stated they plan to keep benchmark interest rate at zero in effort continue to support the economic recovery from the coronavirus pandemic. The Fed has also dismissed concerns around inflation. Claiming it to be transitory, with real inflation rates around 2%. It’s not just lumber though, look around everything is getting more expensive. Whether the Fed wants to admit it or not inflation is here, buckle up.
The wood industry is coming around to the new idea of prices elevated sitting between $800-$1000 as the new normal. Down from current levels, however it used to be $300 MBF. Some might argue the price increase was long over due. But having this all priced in, within such a tight timeframe is not healthy. Sky high prices put a lot of project on the sidelines. Smaller lumber yards are running out of materials to be sold. Shrinking housing inventory is causing people to pay 50k over asking price in cash on current houses for sale, rapidly appreciating all home values. Most of these costs are being pushed through to the end consumer, the home buyer. Pricing out many first time home buyers.
Soaring lumber prices are exacerbating the housing affordability crisis and putting the American dream of home ownership out of reach for millions of people. Is it time we create new alternative building materials or technology in order to build a more affordable house? What we are seeing is likely to get much worse before any sign of recovery. Lumber prices will continue to soar and will likely remain elevated until new capacity is available or the housing market frenzy loses steam. The Fed remains comfortable playing the biggest game of chicken with inflation that any of us have ever seen. They better be right, because if they are wrong about inflation being transitory, then the end of 2021 and start of 2022 could be very painful.