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Key to the demand issue is the U.S. housing market, where some indicators are now pointing toward improvement.JONATHAN HAYWARD/The Canadian Press

Canadian lumber stocks have produced spectacular returns for investors during the stock market rebound since March. For evidence that the gains are sustainable, look south of the border.

Lumber prices are connected to U.S. home building activity, providing a link to the economy that is more direct, and immediate, than many other commodities.

Lumber prices and the shares of lumber-producing Canadian companies were hammered during the worst of the novel coronavirus downturn earlier this year, when authorities halted construction activities and the outlook for the economy turned grim with surging levels of unemployment.

However, prices for western spruce, pine and fir lumber (or SPF) have rebounded 19 per cent over the past six weeks, according to CIBC World Markets. Prices for southern yellow pine lumber (or SYP) have surged 62 per cent over the same period.

As a result, Canadian forestry stocks, which are essentially leveraged bets on lumber, are on a tear. Canfor Corp. has risen 60 per cent from its low in March. West Fraser Timber Co. Ltd. has risen 75 per cent over the same period. Interfor Corp. has more than doubled.

It’s difficult to dismiss the gains as speculative fervour. That’s because immediate demand for lumber appears to be stronger than many observers had expected – at a time when lumber production was cut by 5 per cent last year through extensive mill shutdowns.

Key to the demand issue is the U.S. housing market, where some indicators are now pointing toward improvement. Sales of new homes in April rebounded to 623,000, at a seasonally adjusted annualized rate, according to the U.S. Commerce Dept. That’s up 0.6 per cent from March, next to expectations for a drop of more than 24 per cent – suggesting that low interest rates are supporting the market.

“Given virus-related lockdowns across the country, the latest sales figure was far higher than most expected,” Andrew Burrell, chief property economist at Capital Economics, said in a note on Tuesday.

U.S. home building companies are providing on-the-ground optimism as well. At a conference last week, D.R. Horton Inc., the largest U.S. home builder, said that orders in April were down just 1 per cent year-over-year.

PulteGroup Inc., the third-largest home builder, said that new home orders were down 50 per cent in April compared with the previous year. However, more recent numbers are encouraging: In the last week of April, orders surged to nearly 400 homes, up from 140 orders in the last week of March.

“While job losses in the United States associated with COVID-19 are staggering (over 38 million people out of work), several builders noted that most of the job losses have occurred among low-income households that are not typically in the market to own a home (and certainly not in the more expensive new home market). Builders also pointed to pent-up demand given that the pandemic derailed the spring selling season,” Hamir Patel, an analyst at CIBC World Markets, said in a note.

At the same time, current home owners are driving retail demand for lumber as home improvement projects ramp up, according to the recent first quarter financial reports from retailers. Lowe’s Cos. Inc., for example, reported double-digit increases in lumber sales during its fiscal first quarter, which ended May 1.

If the U.S. housing market and impressive demand for lumber holds up in the months ahead, Canadian forestry stocks have plenty of room to recover more lost ground: While off their lows in March, these stocks remain well below their recent highs. Canfor is 38 per cent below its 52-week high in November. West Fraser is still 40 per cent below where the stock traded as recently as mid-February.

The forestry sector’s recovery over the past two months has been impressive. But the rebound likely still has a long way to go.

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