LUMBER PRICES SAY THIS IS A TOP FOR HOUSING STOCKS

Here is an update to an article I posted in September 2011, describing the leading indication that lumber prices give for the shares of housing related stocks. Back then, it was saying that a rally was ahead for homebuilders, building materials providers, and others involved in the housing industry. And that opinion ran contrary to what was being voiced back then by a lot of other analysts.

Now the commentary I hear on the business TV channels seems largely bullish toward housing stocks. They cite the growing economy, falling unemployment, rising rental prices, and other factors that should benefit the housing sector.

In response, I just cite the message from lumber prices, which peaked a year ago and fell throughout the rest of 2011. Because lumber’s price movements tend to get echoed a year later in the HGX Index and other housing related sector indices, the implication is that we are at a top for housing stocks. Perhaps lumber knows something that the economists don’t.

This relationship does not always work perfectly, and that fact should be understood by anyone contemplating listening to it. A notable difference in behavior was the refusal of the HGX in early 2011 to follow the path of lumber prices up to a giant spike top. But it should be understood that this spike in lumber prices back in April 2010 was due to the earthquake in Chile, which disrupted production of lumber in that country and sent lumber buyers scrambling to lock in supplies.

The reason why this relationship seems to work is that market forces that are going to affect the prices of housing related stocks tend to show up a year earlier as market forces affecting lumber prices. Because the Chile earthquake was an anomalous event, and not a reflection of the interplay of supply and demand forces in a liquid market, that effect did not flow through to housing stocks a year later.

We have not seen a similar anomalous event in the past year that would explain the decline in lumber prices. So it seems reasonable to expect that the market forces which helped push lumber down a year ago should be echoed in 2012 in the share prices of housing related stocks.