An Explosive Move In Lumber (NASDAQ:WOOD)

Thin and illiquid futures markets tend to be far more volatile than markets where volume and open interest are higher. The most liquid futures have open interest levels in the hundreds of thousands or millions of contracts. Daily volume levels are a function of the total number of open long and short positions.

Random length lumber futures trade on the futures exchange in the US. While wood is a significant industrial commodity, and its price can signal overall changes in the economy, the lumber futures arena is far from liquid. As of July 10, open interest in lumber contracts stood at 3,332 contracts. On a typical day, fewer than 500 contracts change hands. When the daily volume exceeds 1000 contracts, it is the exception rather than the norm.

During the risk-off period triggered by the global pandemic in March 2020, the price of nearby lumber futures fell to a low of $251.50 per 1,000 board feet. The low was a price not seen since early 2016.

While the number of coronavirus cases in the US continues to rise, the lumber market has staged a significant comeback. The price rose to a new high for 2020 in July and kept on going. On July 13, wood futures were at the highest price in two years.

The iShares Global Timber and Forestry ETF product (WOOD) holds a portfolio of companies whose fortunes rise and fall with lumber’s price. While lumber futures suffer from problematic liquidity, the WOOD EFT provides an alternative for those looking to participate in the lumber market.

I have never traded one contract of lumber in my almost four decades as a commodities trader. However, I watch the price like a hawk as it can signal significant clues about the US and global economies.

A massive move in the lumber futures market

When markets across all asset classes were melting down in March, nearby lumber futures fell to $251.50 per 1,000 board feet, the lowest price since February 2016.

Source: CQG

As the weekly chart shows, nearby futures more than doubled in price, reaching the most recent high at $583 per 1,000 board feet on July 14. The active month September contract was at the $510 level. The price action filled a gap on the weekly chart from 2018 between $540.20 and $527.20.

Price momentum and relative strength indicators were in overbought territory. The total number of open long and short positions in the illiquid lumber futures arena rose from 2,335 contracts on June 19 to 3,479 contracts on July 13. Increasing open interest and rising price is typically a technical validation of a bullish price trend in a futures market. Weekly historical volatility was below the 25% level on July 14, as the metric edged lower over the past weeks.

Home improvement projects increase demand

Stay at home, and social distancing guidelines caused a boom in home improvement activities. The price action in shares of Lowe’s (NYSE:LOW) and Home Depot (HD) shows that the demand for lumber and other construction materials has increased during the past months.

Source: Barchart

The chart shows that after a move to a low of $60 per share in March during the risk-off period, LOW shares have more than doubled to around the $140 level on July 14. The shares were trading at a new record high.

Source: Barchart

HD shares followed a similar path, falling to $140.63 in March and rising to over $257 on July 14 after trading at a new record peak at $259.29 on June 10.

Lumber is a primary material for home improvement projects, and the increased demand pushed the price of wood futures to its highest price in two years.

Low interest rates are bullish for home building

Short-term interest rates in the US are at zero percent, and the Fed told markets that they are not moving higher any time soon. Meanwhile, quantitative easing and other accomodative monetary policy actions have put a cap on interest rates further out along the yield curve. A decline in the 30-Year fixed-rate mortgage rate at below 3% supports the new home market. As people look to move out of densely populated cities to suburbs or more rural areas of the US, the home building remains robust.

While economic conditions remain uncertain, people are still buying new homes. In my hometown in Las Vegas, the new home building continues to boom as new communities are opening and homes are selling. The migration from California continues to increase the population of Nevada. The bottom line is that a prolonged period of record-low interest and mortgage rates will support the new home construction market and lumber demand.

Moving from cities to suburbs to avoid dense population centers

Coronavirus has changed behaviors, which is impacting markets across all asset classes. The price action in technology stocks is a sign that the pandemic has hastened the demise of retail businesses. Online shopping is replacing a trip to the mall or other outlets, and that trend is likely to continue.

The highly contagious virus spread quickly in the dense cities across the US and the world. In New York City, many residents headed for less populated areas or better climates, and many will not return. Moreover, the cost of the virus will be high. Many states and cities are likely to increase property taxes over the coming months and years. The increasing cost of living in a city or state where tax rates are prohibitively higher will foster population moves. Nevada has experienced significant population growth over the past years and, as mentioned, a lot of the migration is coming from California. That trend is likely to continue as the state offers an attractive tax environment. Tax and health considerations could continue to boost the market for new homes over the coming years.

The WOOD ETF product follows the price of lumber

In 2008, during the global financial crisis, the price of lumber futures fell to a low of $137.90 per 1,000 board feet. The low level of interest rates caused the price to make higher lows and higher highs over the next decade and took the price to a record peak at $659 in 2018. After the pullback to just over $250 in March, the low level of rates and increased demand for lumber could mean that prices will move even higher than the 2018 peak.

Meanwhile, the illiquid lumber market can become extremely volatile. A severe pullback in the futures market could present a buying opportunity for the coming months and years. While new home building and home improvement projects are supportive, the aftermath of the 2020 Presidential election in the US could set the stage for a massive infrastructure project over the coming years. Rebuilding the roads, bridges, tunnels, airports, and other parts of the US’s crumbling infrastructure would keep the demand for lumber rising.

The fund summary and top holdings of the iShares Global Timber and Forestry ETF product (WOOD) include:

Source: Yahoo Finance

WOOD has net assets of $188.99 million, trades an average of 12,642 shares each day, and charges a 0.46% expense ratio. WOOD tends to underperform the lumber futures market on the way higher and outperform when it declines.

Source: Barchart

The chart highlights that the WOOD ETF traded to a low of $39.55 in March, and was at $57.59 on July 14, an increase of 45.6%. Meanwhile, July lumber futures settled at $511.50 on July 14 with the expiring July contract at $583, 131.8% above the price in March.

A healthy market for lumber demand would support the price of the WOOD ETF. Given the recent explosive move, I would rather purchase WOOD on a price correction.

Low mortgage rates, the demand for new homes and home improvement materials, and the potential for an infrastructure rebuilding project in the US are all bullish for the lumber market. The price action since March could mean that the rally is overdone, and lumber is due for a pullback.

The Hecht Commodity Report is one of the most comprehensive commodities reports available today from the #2 ranked author in both commodities and precious metals. My weekly report covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. I just reworked the report to make it very actionable!

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.

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