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Investors are seeing a lot to like in cheaper lumber.

ANDREJ IVANOV/AFP/Getty Images

Lumber prices have fallen sharply from record highs set earlier this year. Yet the share prices of leading Canadian forestry companies are still well up for the year, suggesting that investors see a lot to like in cheaper lumber.

They might be onto something here.

The current price of two-by-fours made from Western spruce, pine and fir is US$510 for every thousand board feet, according to Madison’s Lumber Reporter.

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Yes, that’s down – a lot – from a record high of US$1,650 for every thousand board feet in May. Indeed, the 69-per-cent belly-flop might look like rampant speculation gone wrong. But equity prices have been relatively buoyant over the past six months and remain well above where they started the year, implying the stock market has taken the steep drop in the underlying commodity price in stride.

The share price of West Fraser Timber Co. Ltd. touched its highest level of the year on Monday, closing at $107.52 in Toronto. That’s up nearly 22 per cent since the start of February, when the company completed its takeover of Norbord Inc. and the shares began trading under a new ticker symbol (WFG).

Perhaps more interesting, West Fraser’s share price is higher today than it was in May, when the price of lumber was about three times higher than it is now.

The example of Canfor Corp. isn’t quite as compelling, but makes the same point. Although the share price is down about 16 per cent since May, it is up nearly 28 per cent this year and more than 97 per cent over the past 52 weeks – rewarding long-term investors and suggesting lumber prices are bullish for the sector.

The reasons?

First, that record-high lumber price in May – and the startling run-up in prior months – needs some context: It was a baffling rally that caused tremendous uncertainty among builders and consumers, and caught producers by surprise.

As a result, forestry stock prices never embraced sky-high lumber prices as anything more than a fleeting example of what can happen when demand temporarily races ahead of supply.

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“Volatility is not good for the industry,” Keta Kosman, editor of Vancouver-based Madison’s Lumber Reporter, which provides industry analysis, said in an interview. “How do you make plans for that?”

She says the unusual situation is now working itself out – which is the second point in favour of the forestry sector.

“It looks like normalcy is returning, and that strong underlying demand is still there,” Ms. Kosman said, pointing to continued strength in the U.S. housing market, a key driver of lumber prices.

While U.S. single-family housing starts have settled back in recent months, they remain at relatively high levels and building permits increased in August, implying building activity ahead.

“We expect housing starts to remain around current levels in 2022, as the drop in rates has worked to support home purchase intentions, and demand should also be supported by solid household formations,” Katherine Judge, an economist at CIBC World Markets, said in a note last week.

Lumber prices may be reflecting this upbeat scenario. The price of benchmark two-by-fours may be well off records in May, but the price has crept up by about 25 per cent over the past month, to levels that are far above prices at which forestry companies make a tidy profit.

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That’s a bullish sign, especially for this late point in the building season, when demand for lumber can taper off as winter approaches.

“The trend of the past few weeks, going up a bit each time, is telling me that the mills are in a good position for when real lumber buying starts again next year,” Ms. Kosman said.

She suspects lumber priced at US$500 or more for every thousand board feet is the “new normal.” Forestry stocks, which have essentially dismissed the decline from May’s record-high prices as a non-event, appear to be reflecting a similar view.

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