For the past several months, commodities market commentary has been dominated by a once-prosaic material: lumber. The humble commodity, which is an essential input for most real estate construction, saw its price soar to historic highs just over a month ago.
Now, however, it appears lumber’s price bubble has finally popped, sending its high-flying price hurtling toward earth.
Waning supply meets waxing demand
On May 10, the price of lumber reached $1,711 per thousand board feet, a highwater mark defying decades of established price behavior. Indeed, during the nearly 30 years preceding the recent surge, lumber usually traded within a fairly narrow band, from about $200 on the low end to $600 on the high end.
The unprecedented disruptions created by Covid-19 reverberated across pretty much every industry on the planet, including real estate, and impacted virtually every commodity in some way, including lumber. In the case of lumber, idled production last year resulted in shortages, which intensified in recent months as surging construction demand rapidly depleted reserves. Hence, the price of lumber shot up.
Now, lumber has just posted its biggest weekly loss in history, slipping below $1,000 for the first time since March on June 14. And that was just the latest milestone in a rout that began mere days after May 10. It has now fallen more than 40% from the highs of last month. That may look like a disastrous drop at first, but it is actually little more than a natural correction, in my assessment.
Reversion to the mean
In response to soaring demand, lumber mills were quick to accelerate their operational timelines and to ramp up production in order to take advantage of the historic prices. This is a case of supply and demand in its purest form. Demand has outstripped supply in recent months due to lockdowns and other economic shocks forcing lumber mills to slow, or even suspend, production for a time. At the same time, developers, home builders and other real estate businesses have spent months hoarding lumber in order to ensure they would not run out entirely.
With supply now returning gradually toward normal, the shortages are coming to an end. With prices down more than 40% in the span of a month, it looks like the speculative frenzy could be running out of steam. As the Wall Street Journal reported on June 15, expectations of an imminent return to normalcy has let a lot of air out the lumber bubble:
“The rapid decline suggests a bubble that has burst and the question now is how low lumber prices will fall. Even after tumbling, lumber futures remain nearly three times what is typical for this time of year. Lumber producers and traders expect that prices will remain relatively high due to the strong housing market, but that the supply bottlenecks and frenzied buying that characterizehe economy’s reopening and sent prices to multiples of the old all-time highs are winding down.”
As a widely farmed resource, wood is plentiful. Thus, any shortage will inevitably be temporary. However, such facts are often overlooked in the midst of a speculative frenzy.
Of wood planks and tulip bulbs
Speculative trading has played a considerable role in the unprecedented lumber price spike. Just as with GameStop Corp. (GME, Financial), speculators on Reddit’s WallStreetBets forum zeroed in on lumber as an attractive target for speculative gamesmanship. Based on the astonishing jump in lumber prices, they appear to have been at least partly successful. Unfortunately, those efforts appear to have run out of steam.
Of course, this would hardly be the first time that speculators drove up the price of a commodity to levels beyond any conceivable economic justification. One need only consider the Tulip mania of centuries past. Many of the Dutch speculators who bid up the price of tulip bulbs ended up getting caught when the trade reversed. Today's lumber speculators appear to be learning the same painful lesson.
