It is not the most heavily traded commodity out there, nor does it command the level of attention that gold and oil do, but lumber is now in the spotlight and not in a good way.
Chicago-traded random length lumber, which trades in contracts of 110,000 board feet, traded “limit down” earlier Wednesday, falling to around $287. Lumber futures bounced on Thursday with a gain of more than 4%.
Lumber’s woes could be a harbinger of things to come for two high-flying sector ETFs, the iShares Dow Jones US Home Construction Index Fund (NYSEArca: ITB) and the SPDR S&P Homebuilders ETF (NYSEArca: XHB). ITB dropped nearly 3% today while XHB fell 2.4% just a day after both ETFs rallied on the back of some positive housing data. [Builder ETFs Up As Home Prices See Fast Growth]
ITB and XHB have delivered the goods for investors over the past two years. In that time, ITB has more than doubled while XHB is up nearly 80%. Those gains were accrued on the back of steadily improving housing data. That may continue to be the case as pending home sales will be released on Thursday. Homebuilder ETFs are sensitive to this leading indicator.
Speaking of indicators, that is the potential problem faced by ITB, XHB and their constituents. Professional traders view lumber as a forward looking indicator. With prices of the commodity plunging, it is not unreasonable to say some traders are speculating that demand is falling. The next step is to remember that housing accounts for a significant chunk of lumber demand in the U.S. [Lax Lumber Lifts Two ETFs]
Then there is the technical outlook. The previous four times lumber futures hit the top of the trading channel, the subsequent decline was 50%, according to Chris Kimble of Kimble Charting Solutions. Lumber futures hit the top of the channel 70 days ago and have subsequently tumbled 25%, indicating more downside could be in store for the commodity.
It should be noted that ITB and XHB have not slid 25% in the past 70 days. Actually, both ETFs have traded higher over that time frame, but that does not mean the forecast is entirely sunny. After all, shares of home builders have historically been intimately correlated to lumber futures.
With lumber declining in earnest for more than two months, it is not unreasonable to say ITB and XHB have positively diverged from the commodity that is consumed by so many of the ETFs’ constituents. That may not be a good thing.
“The last serious decline by lumber took place in early 2011. What did the S&P500 do after this lumber decline? SPY declined 17%, peaking in May of 2011,” said Kimble.
What happened to ITB and XHB in 2011? From mid-May through the end of the year, both ETFs lost about 7%.
SPDR S&P Homebuilders ETF
ETF Trends editorial team contributed to this report.