Adam in CO
08-16-2006, 09:47 PM
AUGUST 16, 2006
LUMBER PRICES DROP
Gary Thayer
Chief Economist
This week I saw four economists on TV arguing about whether inflation will subside as the pace of economic activity cools off. The Fed believes it will. Nevertheless, the divergent views of these economists probably reflect the divided opinions that investors have about inflation. Today I thought it would be good to look at some evidence that suggests inflation is likely to subside now that the economy is slowing down.
In the movie .Field of Dreams,. Burt Lancaster.s character, Doc Graham, says something along the lines of: When we are in the midst of everyday life, we often do not see the significance of some of the events that take place. I believe this is often true when we observe the economy. Investors often get focused on one part of the economy and do not see other important things that are happening. For example, most people do not pay much attention to lumber prices, but they probably should.
Back in 2003 deflation was the big concern. The Fed was cutting interest rates, but many investors worried the Fed.s policies would not work. I heard people say you can.t push on a string. Or you can lead a horse to water, but you can.t make him drink. These old sayings reflected investors. concerns that deflation was here to stay and that there wasn.t much the Fed could do about it. If they had been looking at lumber prices in 2003, they probably would not have worried as much about deflation.
Lumber prices started to rise in 2003, and by early 2004 they hit a multiyear high. Nevertheless, many economists still thought in early 2004 that the Fed would hold interest rates down at 1.0% all year long. The strength in lumber prices in 2003 and 2004 was an important sign that the Fed.s reflation policies were working and that deflation was unlikely to become a big problem. The Fed recognized that it had done enough to re-ignite inflation, and it started to raise interest rates in June 2004.
Hindsight shows that the Fed.s reflation policies worked, and inflation − not deflation − is the focus of concern today. In order to prevent inflation from accelerating, the Fed has increased short-term interest rates to the highest level since early 2001. Nevertheless, many people do not believe this tight credit policy will tame inflation. They see rising fuel prices spreading to other items, especially because core inflation has increased this year along with fuel prices. However, before people conclude that inflation will not subside as the economy slows down, they should look at lumber prices.
Lumber prices have been declining for more than a year. This reflects the significant slowdown that is now under way in housing. The housing market peaked in the summer of 2005. Since then home sales have declined and the inventory of unsold homes has increased sharply. As you may expect, homebuilders are not feeling very good about this situation. In fact, this week the National Association of Home Builders reported that its homebuilders index dropped in early August to the lowest level since February 1991. The slowdown in housing is clearly dampening the demand for lumber and is putting downward pressure on lumber prices.
We believe the increase in commodity prices and inflation during the past few years was driven by strong demand for resources, materials, and other goods and services. Consequently, we expect inflation to subside later this year and early next year as the economy cools off and demand declines. The increase in lumber prices
in 2003 and 2004 was a good leading indicator that the Fed.s reflation policies were working. The decline in lumber prices this year could be a good indicator that the Fed.s tight credit policies will dampen inflation later this year or early next year.
So why don.t more people watch lumber prices? Well, lumber is not a glamorous market like gold. You do not have people doing TV, telling you to buy lumber to protect the value of your portfolio. Lumber is also not considered a good hedge against geopolitical uncertainties such as gold. This means lumber probably reflects the developing strength or weakness of the economy better than some of the markets that tend to attract speculation. History would suggest that lumber is often, but not always, a leading indicator of other commodity markets. Consequently, with lumber futures prices recently dropping to the lowest level since early 2003, the long upward trend in other commodity markets could be nearing an end. Only time will tell for sure.
In summary, inflation is likely to subside now that the pace of economic activity is slowing down, and the demand for materials will probably lessen. This is already happening with the slowdown in housing and the recent drop in lumber prices to the lowest level in three years. Past performance is no guarantee of similar results. Nevertheless, lumber prices are often a good leading indicator of other commodity prices. As a result, the decline in lumber prices suggests that the prices of other commodities could decline when the economic slowdown spreads from housing to other sectors of the economy. That is why inflation may subside later this year or early next year.
LUMBER PRICES DROP
Gary Thayer
Chief Economist
This week I saw four economists on TV arguing about whether inflation will subside as the pace of economic activity cools off. The Fed believes it will. Nevertheless, the divergent views of these economists probably reflect the divided opinions that investors have about inflation. Today I thought it would be good to look at some evidence that suggests inflation is likely to subside now that the economy is slowing down.
In the movie .Field of Dreams,. Burt Lancaster.s character, Doc Graham, says something along the lines of: When we are in the midst of everyday life, we often do not see the significance of some of the events that take place. I believe this is often true when we observe the economy. Investors often get focused on one part of the economy and do not see other important things that are happening. For example, most people do not pay much attention to lumber prices, but they probably should.
Back in 2003 deflation was the big concern. The Fed was cutting interest rates, but many investors worried the Fed.s policies would not work. I heard people say you can.t push on a string. Or you can lead a horse to water, but you can.t make him drink. These old sayings reflected investors. concerns that deflation was here to stay and that there wasn.t much the Fed could do about it. If they had been looking at lumber prices in 2003, they probably would not have worried as much about deflation.
Lumber prices started to rise in 2003, and by early 2004 they hit a multiyear high. Nevertheless, many economists still thought in early 2004 that the Fed would hold interest rates down at 1.0% all year long. The strength in lumber prices in 2003 and 2004 was an important sign that the Fed.s reflation policies were working and that deflation was unlikely to become a big problem. The Fed recognized that it had done enough to re-ignite inflation, and it started to raise interest rates in June 2004.
Hindsight shows that the Fed.s reflation policies worked, and inflation − not deflation − is the focus of concern today. In order to prevent inflation from accelerating, the Fed has increased short-term interest rates to the highest level since early 2001. Nevertheless, many people do not believe this tight credit policy will tame inflation. They see rising fuel prices spreading to other items, especially because core inflation has increased this year along with fuel prices. However, before people conclude that inflation will not subside as the economy slows down, they should look at lumber prices.
Lumber prices have been declining for more than a year. This reflects the significant slowdown that is now under way in housing. The housing market peaked in the summer of 2005. Since then home sales have declined and the inventory of unsold homes has increased sharply. As you may expect, homebuilders are not feeling very good about this situation. In fact, this week the National Association of Home Builders reported that its homebuilders index dropped in early August to the lowest level since February 1991. The slowdown in housing is clearly dampening the demand for lumber and is putting downward pressure on lumber prices.
We believe the increase in commodity prices and inflation during the past few years was driven by strong demand for resources, materials, and other goods and services. Consequently, we expect inflation to subside later this year and early next year as the economy cools off and demand declines. The increase in lumber prices
in 2003 and 2004 was a good leading indicator that the Fed.s reflation policies were working. The decline in lumber prices this year could be a good indicator that the Fed.s tight credit policies will dampen inflation later this year or early next year.
So why don.t more people watch lumber prices? Well, lumber is not a glamorous market like gold. You do not have people doing TV, telling you to buy lumber to protect the value of your portfolio. Lumber is also not considered a good hedge against geopolitical uncertainties such as gold. This means lumber probably reflects the developing strength or weakness of the economy better than some of the markets that tend to attract speculation. History would suggest that lumber is often, but not always, a leading indicator of other commodity markets. Consequently, with lumber futures prices recently dropping to the lowest level since early 2003, the long upward trend in other commodity markets could be nearing an end. Only time will tell for sure.
In summary, inflation is likely to subside now that the pace of economic activity is slowing down, and the demand for materials will probably lessen. This is already happening with the slowdown in housing and the recent drop in lumber prices to the lowest level in three years. Past performance is no guarantee of similar results. Nevertheless, lumber prices are often a good leading indicator of other commodity prices. As a result, the decline in lumber prices suggests that the prices of other commodities could decline when the economic slowdown spreads from housing to other sectors of the economy. That is why inflation may subside later this year or early next year.