Home building: Luxury demand ‘facing the worst times,’ analyst says

Corton Capital Timber Analyst John Duncanson joins Yahoo Finance Live to talk about the lumber market, the outlook for home building, and lumber mill profitability.

Video Transcript

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JULIE HYMAN: Just two months after signaling a rebound, the US homebuilding market slowing again. The S&P Homebuilders Index dropping two days in a row this week. And that slowdown has also been having an impact on the lumber market. But to what extent? Let's bring in Corton Capital Timber analyst John Duncanson to discuss. John, good to see you. So as we look at what the dynamics in the construction market here in the US, residential construction, what feedback is that having to the lumber market?

JOHN DUNCANSON: Well, prices have weakened here in the last couple of days. They had bounced off the bottom. This is a cash market. I don't look at the futures market. We're in the summer doldrums. But higher interest rates are definitely having an effect on housing and housing affordability in particular. My crystal ball shows lumber prices probably getting close to bottoming out here at 600. A year ago, they went as low as 385.

But I see there's a lot of mill shutdowns happening in Western Canada and particularly in the Pacific Northwest with the fire situation, the wildfires. So the mills are taking quite a bit of downtime. And the one figure I do look at, though, is just inventories. And they're pretty well close to bottom. So any bit of activity as we get into the fall season and the fall building season, things could tighten up quite nicely.

And remember, last year, we bottomed out mid-August. So we're almost at that point now. And then they really rallied back up to four digits pretty quickly going into the winter months. So I don't see an exact repeat of last year, but I think that the-- I wouldn't be panicking and selling my lumber stocks here because there's still-- even at these levels, they're still very profitable to the mills. And--

BRIAN SOZZI: John--

JOHN DUNCANSON: --if you look at the US southern lumber prices, they actually ticked up last week. And in the southeastern part of the US, southern yellow pine lumber is now trading about $800. And the mill costs are about 300. So the mills are still very profitable in the US, so.

BRIAN SOZZI: John, how do you see that fall building season playing out?

JOHN DUNCANSON: I think, well, it's really a call on interest rates, inflation. But there is definitely a pent-up demand or lack of housing, new housing stock out there. So it doesn't take too much to trigger it. Some of the luxury home builders are probably going to be facing the worst times. But some of the companies that are making more affordable housing should see a pretty steady demand going into the fall and winter.

So I'm not as doom and gloom as some other analysts are out there, so. But I think you have to look at the supply situation. The other thing I'm looking at, too, is the effect of the war in Ukraine with Russia. Russia has been shut out of the global wood market and Russia is the largest lumber producer on the planet.

And we haven't seen the data yet, but European lumber will be starting to flow back into Europe to meet the shortfall in Russian lumber. So we have some new set of variables out there we haven't seen before. So I think that supply, I think, could tighten up quite nicely here.

JULIE HYMAN: I also want to ask you about the Canadian-- the duties on Canadian lumber that has been coming into the US. And I think that they're set to be reduced, if I'm not mistaken. What effect is that going to have?

JOHN DUNCANSON: It won't have much effect on lumber prices. But I think it will have an effect on-- it will definitely add to the positive tone of the market as we go into the fall. And you're right. The Commerce Department announced the preliminary duties back in January. These are the ones that will go into effect probably as early as Monday. And that's a big drop. It's about 35% drop.

So that's going to make Canadian lumber more affordable because right now, in a tight market, the Canadian producers have just been compensating by adding that to the price. So we may see some softening in lumber prices there. But I think psychologically, it's a very positive event. So the Commerce Department will deliver the final rates, which aren't expected to change from the preliminary ones announced in January.

So we're going to see the rate go from roughly 18% down to 11 and 1/2%. And that will be in effect in effect for another year. But that's a big drop. And how the mechanism works at the Commerce Department is that every year, the Commerce Department does an administrative review. And one of the big input costs in determining the tax rate is the lumber selling price.

So the prices that we will see, the new rates are going to be based on 2020 lumber prices. The next review will be based on 2021. And we saw quite a spike up in lumber prices. So the next round of duty reviews will probably drop it from 11 and 1/2% maybe down to as low as 6%.

Then you'll see a lot of pressure at that point, where the American home builders are basically going to try to push the Biden administration. So let's end this tax war. It's just a tax war on the US consumer. So it'd be interesting to see what the market reaction is to it in the next 24 hours, so.

BRIAN SOZZI: All right, well, we'll leave it there. John Duncanson, Corton Capital Timber analyst, always good to see you. We'll talk to you soon.

JOHN DUNCANSON: Thank you. Bye.