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What the Timber Market Is Telling Us

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Lumber prices serve as a key leading indicator for housing.

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Commodities, to varying degrees, have suffered a tough time this year, leaving bulls on the commodity complex sounding cautious here in the near-term.

Gluskin Sheff's David Rosenberg holds fast to his long-term constructive view on commodities, but the noted investment strategist did warn his readers towards the end of 2009, when he wrote that the positive trend over the past year could experience a near-term pause or even a technical correction that could last for several months.

"This is indeed what is happening right now," Rosenberg pointed out earlier this week. "There is a flight to safety taking place, which benefits the dollar -- the greenback has broken out, in fact to the upside -- at the expense of those items that are priced in dollars."

Interestingly, though, a standout among the commodities this year has been one that many investors typically don't spend a lot of time paying attention to: lumber.

In his morning missive today, Jon Markman of Markman Capital Insight notes that raw lumber is up more than 25% this year even as the home construction business -- its main use -- has been scrambling at record lows.

What's going on?

Markman emphasizes that production has fallen too much even for weak demand, sending prices higher.

"In other words, because there has been so little demand for lumber to build houses, timber companies have cut back on their harvesting and cutting," the market pro wrote to clients. "So now that home production is picking up a little, as suggested in some earnings and economic reports this week, marginal new demand is pushing up the price of this surprisingly scarce commodity."

Tom McClellan, editor of The McClellan Market Report, eyeballs the charts and sees this as a positive sign.

Lumber prices have now broken an important downtrend line, he says, and that's very important judging by the price behavior after similar lines were broken in the past.

Specifically, McClellan has done his homework on the lumber-housing relationship, finding that lumber prices serve as a leading indicator for the housing market.

In the chart below, the price of lumber is shifted forward by one year to show its leading indication for home sales volumes:



The December new home sales data showed a continued drop, the technician wrote, and he thinks we'll probably see another in January because of the one-year leading indication (January data will be released later this month). But, he says, the housing market data for months following January should start to improve.

Bottom line, says McClellan: "Things are finally showing improvement in the lumber markets, which is where improvement typically first appears."

Yesterday, investors grew excited after homebuilder D.R. Horton (DHI) posted its first earnings since 2007 during its fiscal first quarter.

Much of its $192 million profit during the October-December period came from a tax gain, notes the AP, but its revenue rose because of a 36% increase in home sales. Orders climbed 45%.

D.R. Horton jumped on the news as did other homebuilders, including Toll Brothers (TOL) and Pulte Homes (PHM). (All three, as we write here at midday, are in the red.)

As for investment implications to all this, Markman writes that the SPDR Homebuilders ETF (XHB) has doubled from its March 2009 low but has flat-lined since, waiting for the economics of the industry to pick up.

"Watch for a potential breakout with a monthly close over approximately $16.50, but don't hold your breath as it may be awhile," Markman argues. "Employment trends are still weak, and homebuilders have disappointed investors for four years running."
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