I have been trading commodities for the past four decades. Over that time, I have had risk positions in almost all raw materials worldwide. However, I have never traded one contract of the random length lumber futures. The low open interest and volume levels make the market more than a challenge. Lumber is a roach motel. A trader or investor can find the liquidity to get into a long or short position but watch out if it goes sour. Getting out can be another story. Thin and illiquid markets tend to suffer from price gaps that can cause lots of financial pain.
While I have never dipped a toe into the lumber futures arena, I watch the wood price like a hawk. I have found that it can provide valuable clues about the overall trends of other raw material prices. The thin lumber market tends to move higher or lower in advance of other industrial commodity markets.
Trading lumber is a no-no, but there are ETF, ETN, and equity products that track the wood price. The iShares Global Timber & Forestry ETF product (WOOD) holds shares in companies that tend to move higher and lower with the price of lumber. The last time I wrote about the WOOD ETF product on Seeking Alpha was on August 28 when the price of nearby lumber futures reached a record high of $887.30 on August 27 and the WOOD product was at $66.24 per share.
Lumber rose to an unsustainable level
Before 2018, the all-time high in the lumber futures market came in 1993 at $493.50 per 1,000 board feet. In May 2018, lumber reached a new record high of $659 before declining to a low of $251.50 in April 2020.
As the monthly chart highlights, the wood price reached a high of $1,000 per 1,000 board feet in September, a new record high. An almost perfect bullish storm in the lumber market lifted the price to an unsustainable level. Lockdowns caused a rise in the demand for wood for home improvement projects, and low interest rates and migration from urban areas increased new home construction. Meanwhile, slowdowns at lumber mills created a supply shortage, tilting the wood market’s fundamental equation.
Lumber rose to $1000, but the air was thin at $341 above the prior record high from May 2018. As of November 3, lumber’s price for March 2021 delivery was trading at the $525 level.
Illiquid markets do crazy things, but there is sanity in the insanity
The monthly chart shows that price momentum and relative strength indicators were on either side of neutral readings on November 3. Monthly historical volatility was at 100.4%, thanks to the wide trading ranges from July through October. The monthly price variance metric remained at a historic high as of Tuesday.
Meanwhile, open interest at 2,690 contracts declined from the high for 2020 at 4,775 contracts in mid-August when the price of wood was on its way to the high in September. The last time that over 1,000 contracts changed hands in a session was on September 9. Lumber volume has not exceeded 700 contracts since mid-September.
Lumber is an illiquid futures market, which leads to wide bid-offer spreads, and extreme price moves at times. When buying or selling overwhelms the market, the lack of liquidity leads to price gaps to the up or downside. However, the lack of liquidity often reveals changes in price trends in commodity and other markets before they take hold in more liquid markets. Therefore, the price action can be a useful barometer at times.
The monthly chart shows that in early 2009, lumber hit a low and rallied until 2010, while most commodity prices were moving higher. In 2011, when raw materials reached peaks, lumber made a marginally lower high than in 2010, which signaled the end of the rally for the asset class.
In late 2015 and early 2016, many commodities reached multiyear lows as the Chinese economy cooled, and the days of double-digit percentage GDP growth ended. Lumber hit its low in September 2015, a few months before most other commodity futures markets reached bottoms. The recovery in lumber was a bullish sign for the asset class. Lumber turned lower from a record high in May 2018, months before the stock market and commodities fell at the end of that year. Most recently, after reaching the record high of $1000 in September, the price of wood was substantially lower by the end of that month. Stocks and many commodities corrected to the downside in October. The illiquidity of lumber that leads to insane moves provided clues and sanity for other markets over the past dozen years.
Lumber is consolidating as the winter approaches
After halving in value since the September high, the lumber price is attempting to consolidate into the winter months.
The chart illustrates that the lumber price hit its most recent low of $490.80 during the final week of October and was trading above the $520 level on November 3. Weekly price momentum was in oversold territory with relative strength just below a neutral reading. Lumber demand tends to decline during the winter months as construction projects slow. However, the price above the $500 level is still at a high level considering it never reached $500 until 2017. Consolidation around the current price over the coming months could lead to another bullish run in 2021.
Another rally is in the cards for the spring, which could signal higher commodity prices as they lag the price of wood- A US infrastructure program would boost the demand for lumber
Lumber price action has been an excellent predictor of trends in the overall commodity asset class and the stock market over the past years. The level of central bank liquidity and the Fed’s plans to tolerate higher inflationary pressures are bullish for the price of wood and all raw materials. Unprecedented government stimulus led the US Treasury to borrow a record $3 trillion in May 2020, surpassing the previous record of $530 billion from June through September 2008. Another stimulus package later this year or in early 2021 would only increase the money supply and deficits, weighing on the purchasing power of fiat currencies. The flight of people who work from home in urban areas will continue to flock to other areas of the country, supporting new home construction demand. Moreover, rising taxes in the leading cities could push even more people to seek refuge in states where tax rates are lower.
Meanwhile, while there has been a lack of bipartisan support for anything in the US leading up to Tuesday’s election, Democrats and Republicans agree that an infrastructure rebuilding program is long overdue. An infrastructure initiative would kill two birds with one stone. It would provide much-needed jobs in the wake of the global pandemic and finally begin rebuilding the crumbling roads, bridges, tunnels, airports, and other parts of US infrastructure. The last time the US had a national project of the necessary scope was in the 1950s when the Eisenhower administration built and expanded interstate highways and roads. Infrastructure rebuilding would require construction raw materials, including lumber.
WOOD an ETF that is sensitive to the price of random length lumber futures
The lumber futures market has had an excellent predictive record over the past years regarding trends in commodities and other asset markets. I would never recommend a risk position in lumber because of its lack of liquidity. There are no ETF or ETN products that directly track the price of wood futures.
However, the iShares Global Timber & Forestry ETF product (WOOD) holds a portfolio of companies that tend to move higher and lower with the price of lumber, including:
Source: Yahoo Finance
Source: Yahoo Finance
WOOD has net assets of $188.99 million, trades an average of 34,873 shares each day, and charges an expense ratio of 0.46%. The blended yield of the stocks in WOOD’s portfolio was at the 1.07% level.
The price of lumber futures rose from $251.50 during the week of March 30 to a high of $1000 per 1,000 board feet in mid-September as the wood price almost quadrupled. Since then, lumber futures have almost halved in value to the $525 level on November 3.
Over the same period, the WOOD ETF rose from $39.55 to $68.59 per share or 73.4%. At $66.10 on November 3, WOO was only 3.5% below the most recent high.
WOOD trends to underperform the illiquid lumber futures market on the upside and outperform when the price corrects.
Central bank liquidity, government stimulus, the need for an infrastructure rebuilding program in the US, and the flight of people from urban and high taxes areas, are all bullish factors for lumber demand over the coming months and years. Moreover, watch the price action in the lumber futures market as it is often an excellent barometer for commodities and markets across all asset classes. Lumber tends to move first, so look for sudden price volatility in the random length lumber futures contract.
On Saturday, November 7, at noon EST, Bubba Horwitz and Andy Hecht will host a joint webinar to discuss the state of markets across all asset classes in the aftermath of the 2020 US election.
At Saturday’s webinar, the two traders explain their approach to markets over the coming weeks and months from a technical and fundamental perspective. They will also reveal the tools in their decision-making process for establishing risk positions.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.