Why Is Lumber Valuable?
Lumber is the term for wood that has been processed into beams or planks of varying lengths. It is a key commodity for a variety of industries including homebuilding, furniture manufacturing, wood flooring and kitchen cabinetry.
Evidence shows that the use of wood in construction precedes written history. In a site near Nice, France, archaeologists discovered a hut constructed with wooden supports that was built more than 400,000 years ago. Early craftsmen used iron axes, saws and chisels to cut wood. However, by around 375 AD, sawmills – facilities for processing wood – began operating in Northern Europe.
Today lumber, which is also known as timber,contributes $600 billion to the global economy. This equates to 1% of total global GDP. With demand for lumber expected to quadruple over the next three decades, the commodity will play a vital role in the international marketplace.
How Is Lumber Produced?
Loggers use two categories of trees to produce lumber – hardwoods and softwoods.
About 80% of all lumber comes from softwood trees.
|Description||Produced from flowering trees that usually have broad leaves . Hardwood trees shed their leaves in the winter.||Produced from trees that don’t produce flowers or fruits and usually have needles and cones. Softwood trees don’t shed their needles and remain green throughout the year.|
|Uses||High-quality furniture, decks, flooring and higher-end construction projects including paneling and trim work.||Windows, doors, lower-end furniture, medium-density fiberboards, paper, Christmas trees and construction including wall studs, rafters, beams and posts.|
|Examples||Alder, balsa, beech, hickory, mahogany, maple, oak, teak, walnut||cedar, Douglas fir, juniper, pine, redwood, spruce, yew|
|Growth||Trees take longer to grow||Trees grow more quickly|
|Length Availability||4 - 16 feet||4 – 24 feet|
Both hardwood and softwood lumber receive grades based on the quantity and types of defects in the wood.
Defects include knots, holes, splits and missing pieces on the corners or edges.
|First or Second||The highest grade and reserved only for grading some hardwoods. First- and second-grade hardwoods have very few defects and are used in projects where appearance is important (e.g., trims and moldings)|
|Select||The highest grade for softwoods and some hardwoods.|
|Common||The lowest grade wood. Common-grade woods are used in projects where the wood will be covered and defects won’t be noticed. Common-grade woods are further classified by number in descending order of quality (e.g., #1 common, #2 common, etc.)|
Lumber designated for non-construction uses such as boxes or paper may be given other grades to classify its quality.
The lumber manufacturing process takes place in several steps:
Loggers visually inspect trees and designate those ready to be cut down. Most felling takes place using gasoline-powered chainsaws. Workers make two cuts at the base of the tree to control the direction of the fall.
Once the tree has fallen, loggers trim the limbs with chainsaws and cut the tree into pieces for transportation. Diesel tractors or self-propelled yarders drag the tree pieces to a cleared area where they are loaded on trucks for transportation to lumber mills.
Debarking and Bucking
Sharp-toothed grinding wheels or high-pressure water jets remove the bark from the tree pieces. Chain conveyers then carry the pieces into the mill where they are cut into predetermined lengths.
Millworkers saw the log pieces in one of two ways depending on the size of the logs.
Logs larger than two to three feet in diameter are clamped into a movable carriage and scanned with optical sensors. These sensors determine the optimal cutting pattern to maximize the lumber yield from the log.
A vertical band saw called a headrig saw makes a series of cuts. The first cut produces a piece of wood known as the slab. This piece is usually discarded and ground into paper pulp. Subsequent cuts produce logs of varying sizes.
Band saws process the logs smaller than two feet in diameter by cutting them into one-, two- or four-inch thick pieces with one cut.
Chain conveyers move the large pieces cut by the headrig saw. Multiple-blade band saws then cut these pieces, which are known as cants, into predetermined sizes and trim the outside edges into squares.
Kilns or air dryers remove the moisture from the cut pieces. The pieces are stacked in covered areas with space between each stack to allow air to circulate. Air-dried lumber typically retains about 20% moisture while kiln-dried lumber retains less than 15% moisture. Interior floors, molding and doors often require kiln-dried lumber since its lower moisture content means less shrinkage.
Mechanical or manual inspectors then grade each finished piece of lumber and stamp this information on the lumber along with the identification number of the mill and the moisture content.
Workers then bundle the pieces with steel bands and load them on to trucks for shipment to lumber yards. Lumber yards then sell the products to consumers.
Global Lumber Production
The Food and Agriculture Organization of the United Nations keeps statistics on forestry products based on these categories:
Industrial Roundwood: Logs used for purposes other than energy. This includes pulpwood, sawlogs and veneer logs as well as round logs used for telephone poles, fence posts and electricity poles.
Sawnwood: Planks, beams, boards, laths, etc. that exceed 5 mm in thickness.
Wood-Based Panels: Veneer sheets, plywood (including blockboard), particleboard, Oriented Strand Board (OSB) and fibreboard.
Fibre Furnish: Fibre used to manufacture paper and paperboard.
Paper and Paperboard: Graphic papers (newsprint, printing and writing paper) and products such as wrapping and packaging paper, household and sanitary paper, and other miscellaneous paper products.
Wood Fuel, Charcoal and Pellets: Roundwood used as fuel for cooking, heating or power production including wood used to make charcoal and pellets.
Top 5 Industrial Roundwood Producing Countries
|#1||United States of America|
UN Global Forest Products – facts and figures
Top 9 Exporters of Wood Products of all Categories
3 Main Uses of Lumber
|Uses of Lumber||Description|
|Construction||Lumber is used in a variety of residential construction projects:|
|Furniture||Many home and office furnishing items are made from lumber including chairs, desks, beds, tables and nightstands.|
|Flooring||Lumber is used in constructing indoor flooring and outside decks.|
What Drives the Price of Lumber?
The importance of lumber to the construction industry makes it a highly economically sensitive commodity. Specifically, these four factors most directly drive its price:
- Construction and Housing Data
- Trade Policies
- Availability and Price of Substitutes
Construction and Housing Data
Lumber is, by far, the most important building material used to construct new homes. On average, a new home contains 15,000 board feet of softwood. In addition, new home buyers typically purchase furniture and accessories made from both softwoods and hardwoods.
Lumber traders carefully monitor housing starts and construction data for clues about future demand. A surge in new home starts could mean a tight supply for the commodity and higher prices in the near- and intermediate-term. More generally, macroeconomic data such as nonfarm payrolls and GDP can also impact future lumber demand.
The United States is the largest consumer of roundwood and, along with China, consumes the vast majority of the global supply of sawnwood.
However, the United States is unable to meet its demand through domestic production and relies heavily on imports from other countries. Canada supplies nearly one-third of US annual lumber consumption. Although the two countries share a border and a long history of friendly relations, they also have a history of trade tensions.
The imposition of tariffs and quotas in the United States can have a major impact on lumber prices.Similarly, the extent to which Canada and other exporters subsidize lumber production can also impact prices.
Availability and Price of Substitutes
Wood competes with other building materials such as plastics and metals. The demand for each of these materials will fluctuate mostly based on price and availability.
If manufacturers can source alternatives at a lower cost than lumber, then they will usually substitute those materials for wood.
Of course, if lumber prices are significantly lower than other materials, then builders might increase their demand for wood as a building material. These changes in demand can impact lumber prices.
Forest loss and forest change are two factors that can influence the supply of trees and, ultimately, the price of lumber.
Forest loss, also known as deforestation, occurs when people clear forests in order to make land available for industry. Deforestation can limit the availability of trees and the supply of lumber. Fears of deforestation can also lead countries to impose restrictions on logging and limit the availability of land allocated to the industry. Ultimately, deforestation can lead to higher prices for lumber.
Forest change can occur when the composition and fertility of soil diminishes. This can lead to lower forest yields and smaller harvests. Ultimately, diminished output produces higher lumber prices.
3 Reasons You Might Invest in Lumber
Investors purchase commodities such as lumber for many reasons, but the most important ones include:
- Inflation and Weak US Dollar Hedge
- Bet on Demand Growth
- Portfolio Diversification
Inflation and Weak US Dollar Hedge
Investing in lumber is a way to bet on a weak US dollar and higher inflation.
Commodities such as lumber are priced in US dollars, so the performance of the world’s largest economy plays a crucial role in their pricing. The US Federal Reserve Bank has kept interest rates low and the US dollar weak for many years.
US central bankers are likely to continue these policies to support consumer borrowing and consumer spending. These conditions are likely to be very beneficial for lumber prices.
A weak dollar could stoke inflation concerns. Since there are a limited supply of trees, the price of lumber would likely benefit from fears of inflation.
Bet on Demand Growth
A low interest rate environment combined with a rebounding housing market is likely to be a very beneficial environment for lumber prices. Housing prices are very sensitive to interest rates since interest rates determine mortgage rates. As long as rates remain near historically low levels, demand for housing, and therefore lumber, should continue to remain strong.
Most traders have the vast majority of their assets in stocks and bonds. Commodities such as lumber provide traders with a great way to diversify and reduce the overall risk of their portfolios.
Should I Invest in Lumber?
Traders who want exposure to lumber prices should consider purchasing lumber along with a basket of other commodities that includes agricultural commodities (i.e., dairy, meats and grains), as well as metals and energy. Purchasing a basket of commodities helps protect traders from the volatility of any individual commodity. It also adds overall diversification to a stock and bond portfolio.
There are two specific trends that could raise lumber prices in the years ahead:
Housing Demand: Demand for housing is likely to rise worldwide in the years ahead. Emerging market countries such as China and India are building more wealth and creating rising middle classes. Demand for lumber products to construct and furnish homes should continue to grow as a result of housing demand.
Deforestation: There is a limited amount of land, and many industries such as livestock and farming compete with loggers for land. This competition has the potential to create lumber shortages.
However, traders should also consider the risks of investing in lumber:
- A global spike in interest rates could weaken housing demand and depress lumber prices.
- Overproduction by large lumber companies could depress prices.
- Global economic or political turmoil could weaken demand for commodities in general.
Expert Opinions on Lumber
Experts are generally ambivalent about the direction of lumber prices.
In the view of one National Association of Home Builders (NAHB) economist, a pattern of devastating natural disasters in the United States, including wildfires and hurricanes, should fuel demand for lumber as homeowners rebuild. However, this demand may come at the expense of lumber demand for new construction:
“Across the nation, there typically is no persistent impact [on lumber prices] over the medium-term. One of the reasons is that construction activity during the rebuilding process will often times partially offset the decreased demand for lumber in new-home construction.”
Robert Dietz, NAHB Chief Economist
Another NAHB economist believes more time is needed to assess the effects of natural disasters and new trade policies on lumber prices:
“Other factors are also at play right now, which further complicates things. The wildfire outlook is uncertain at this point, and duty rates on Canadian lumber are being reevaluated.”
David Logan, NAHB economist
How Can I Invest in Lumber?
Investors have several ways to gain exposure to lumber prices:
Lumber Trading Methods Compared
|Method of Investing||Complexity Rating (1 = easy, 5 = hard)||Storage Costs?||Security Costs?||Expiration Dates?||Management Costs?||Leverage?||Regulated Exchange?|
The Chicago Mercantile Exchange (CME) offers a contract on Random Length Lumber Futures. Each contract represents 110,000 board feet. The underlying product is two-inch by four-inch lumber that is between eight and 20 feet long.
The contract trades globally on the CME Globex electronic trading platform and has expiration months of January, March, May, July, September and November.
Futures are a derivative instrument through which traders make leveraged bets on commodity prices. If prices decline, traders must deposit additional margin in order to maintain their positions. At expiration, the contracts are physically settled by delivery of lumber.
Investing in futures requires a high level of sophistication since factors such as storage costs and interest rates affect pricing.
Lumber Options on Futures
The CME offers an options contract on Random Length Lumber Futures.
Options are also a derivative instrument that employs leverage to invest in commodities. As with futures, options have an expiration date. However, options also have a strike price, which is the price above which the option finishes in the money.
Options buyers pay a price known as a premium to purchase contracts. An options bet succeeds only if the price of lumber futures rises above the strike price by an amount greater than the premium paid for the contract. Therefore, options traders must be right about the size and timing of the move in lumber futures to profit from their trades.
These financial instruments trade as shares on exchanges in the same way that stocks do. There is no ETF that offers pure-play exposure to lumber prices. However, there are two ETFs that invest in companies that have exposure to the lumber industry:
Top 2 Lumber ETFs
|iShares Global Timber & Forestry ETF||Guggenheim MSCI Global Timber ETF|
Shares of Lumber Companies
There are no public companies that are a pure-play investment in lumber. However, traders that want exposure to lumber prices may want to consider buying shares in three companies that own and manage timberlands used to produce lumber:
One way to invest in lumber is through the use of a contract for difference (CFD) derivative instrument. CFDs allow traders to speculate on the price of lumber. The value of a CFD is the difference between the price of lumber at the time of purchase and its current price.
Some regulated brokers worldwide offer CFDs on lumber. Customers deposit funds with the broker, which serve as margin. The advantage of CFDs is that trader can have exposure to lumber prices without having to purchase shares, ETFs, futures or options.
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