Source: www.CMEGroup.com 

Specifications and Statistics

Lumber futures began trading on the Chicago Mercantile Exchange (CME) in 1969 via open outcry, and in 2008, lumber began trading electronically on the Globex platform. Futures trading allows the lumber industry to hedge against events like mill closings, environmental policies, geopolitical events, and high-interest rates.

The National Association of Home Builders reports that a typical home of 2,400 square feet uses about 14,400 board feet of softwood lumber. Approximately two homes are built with one futures contract. The new lumber futures contract size is 27,500 board feet. 

The US is the world's largest producer of wood products, followed by Canada. As of 2018, the US was the 3rd largest exporter, following New Zealand and Russia. 

Unfortunately, the lumber futures contract is highly illiquid. On average, the daily volume is 15 contracts. The average open interest is 150 contracts. The new contract has only been trading since August 2022. Perhaps the contract will get more liquidity when the next home-building season begins. 

The front-month contract is November, trading at $590.00 per 1,000 board feet. The notional value of the lumber futures contract would be $16,225 requiring $2,125 per contract for a margin with leverage of 7:1.   

The average daily range for lumber futures is 25.00 points, and multiplying the dollar point value ($27.50) shows that the market moves from low to high, approximately $690.00 per day. 

Lumber Futures Recent Performance 

Since trading to all-time highs of $1,733 in May 2021, the lumber futures sold off to the mid $400s and returned to a lower recovery high of $1,357 in March 2022. Since then, the lumber price has steadily fallen. 

During the last three months, the price has dropped 20%. Year-to-date performance is down 49%. 

Fundamentals of Lumber 

Building materials are feeling the effect of higher interest rates. Today the 30-year fixed mortgages are approximately 7% compared to last year's low yields of 3.5%. Each 1% of a mortgage rate increase prices out roughly $100,000 of mortgage qualifying. As the mortgage rates rise, new home sales are dropping. 

Another sector feeling the pinch is home improvement stores. With lower demand for new homes, the lumber industry is seeing a backlog of lumber piling up at wood mills. Could this impact future earnings for Lowes and Home Depot?    

Seasonality 

Source: Moore Research Center, Inc. (MRCI) 

Now we are at the objective of this article. As homebuilders prepare for the 2023 building season, lumber is accumulated. MRCI shows lumber prices usually bottom for the year near the beginning of October. The seasonal low is also supported by the 30, 15, and 5-year patterns putting in a simultaneous low. 

Reviewing the weekly lumber chart above, last year's seasonal low was made in September and peaked in March, much like the MRCI seasonal pattern above. The warmer spring weather supports this seasonal pattern, allowing construction to begin around the country. The accumulation of lumber starts in the prior October to allow for delivery and milling of material. 

Before we discount this year's seasonal pattern because of the higher interest rates, I looked at interest rates in the 1990s, which were 10.13%. The higher rates are having an impact on the current inventory of lumber. Looking at the seasonal pattern shows that demand drops from March to October. If demand is already declining due to seasonality, then the higher interest rates dramatically impact the lumber prices during this period. The question becomes, "Will there be demand for lumber in 2023?" If I were to say yes or no to this question, I would personally be guessing. But what if I consulted the professionals who use lumber every day? 

The Commitment of Traders (COT) Report

Since I don't have any elite status in the lumber industry, I rely on the next best thing, the COT report. Since this contract has little volume, I only look to see how the commercial traders are positioned. Commercial traders are very knowledgeable about the products they produce or process. They are well-informed about the seasonal buying patterns of their products. 

The COT chart above has a one-year duration. Observing the current red bar on the right scale showing 1,156 contracts indicates that commercials have many more long positions than short positions (based on the larger lumber futures contract). Their current market position is the most bullish they have been at any time in the past year. This bullishness coincides with a seasonal low for the past 30 years. 

Summary 

Trading the lumber market is not for the faint of heart. Unless you are hedging in the lumber market, I would advise avoiding making trades. 

The housing market is a substantial part of our country's GDP. New homes lead to more purchases of appliances, furniture, carpets, etc. 

As traders, we need to confirm fundamental stories to verify their validity. Understanding how and when the lumber market prices move could give you an inside edge on the strength of the overall economy. 

When following economic reports for the housing sector, remember that building permits are more critical than new home sales. Building permits must be obtained before the ground can be broken for new home construction. 

Another commodity that is used heavily in the home building industry is copper. Homes in the US have approximately 400 pounds of copper per house. November is usually the seasonal low for that market. 

If lumber and copper can show strong commercial accumulations, we may be in for another good spring in the home-building sector. Keep studying the markets and forming your independent analysis.

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