The Chicago Mercantile Exchange rolled out the physical lumber contract in 2023 to attract more volume for hedgers and other market participants. The physical lumber contract is smaller than the old random-length contracts and has more flexibility regarding delivery and grades. Unfortunately, the volume and open interest have not grown, but lumber remains a significant bellwether commodity. Since lumber is a main ingredient in new homebuilding, wood is an essential indicator of the demand. Moreover, lumber prices are highly sensitive to interest rates as rising or falling mortgage rates dictate the demand for new construction.
In a November 17 Barchart article, I wrote, “As the spring approaches, the odds favor the upside in the lumber futures arena.” In explaining how lumber can lead other commodity prices, I explained:
The lumber futures market is highly illiquid, as the industrial commodity does not attract significant hedging or speculative volume. Open interest, the total number of open long and short positions in the lumber futures arena, remains at a low level compared to other industrial raw material markets.
Low liquidity causes extreme volatility in price trends. Upside price moves can cause offers to sell to disappear, while downside price action often comes without bids to purchase wood. Therefore, trends can lead to significant price moves to levels that defy rational, reasonable, and logical supply and demand fundamentals.
Meanwhile, lumber is a bellwether commodity that reflects economic conditions. Therefore, extreme price moves in lumber can portend bullish or bearish price action in other industrial commodities like energy or metals.
Nearby January physical lumber futures were at $539 per 1,000 board feet on November 17. On December 22, the March contract price was higher at the $585.50 level.
A bullish trend could be developing
After trading just below $500 per 1,000 board feet on October 25, March physical lumber futures have made higher lows and higher highs.
The chart shows the rise to over the $590 level, with March futures trading near the recent peak on December 22. The U.S. Fed validated the bullish trend at the early December FOMC meeting.
The Fed set the stage for a rebound in new home demand
The U.S. central bank surprised markets at the early December FOMC meeting. While the market had expected the Fed to continue to pause rate hikes after favorable November consumer and producer price index data, the central bank’s rate cut forecasts for 2024 indicated a pivot from a hawkish to a more accommodative monetary policy approach.Thirty-year conventional fixed-rate mortgage rates below 3% in 2021 had risen to over 8% in October 2023. While the rise in home financing costs caused borrowing to grind to a halt, the lack of existing home supplies kept prices high. Homeowners locked into fixed-rate mortgages below 4% would not sell their homes to trade up or down with rates at double that level. Therefore, home supplies dwindled.
The prospects for rate cuts will not likely increase existing home supplies but will cause rising demand for new construction. More new homes translate to increasing demand for lumber, a critical construction ingredient.
The levels to watch on the upside
Lumber prices rallied from the October low when the U.S. 30-year Treasury bond futures reached the lowest level since 2007. The recovery in bonds supports higher lumber prices.
The three-year physical lumber futures chart highlights the first upside target at the July 2023 $593 per 1,000 board feet high. Above there, technical resistance is at the January 2023 $627, September and October $655, and August 2022 $712 per 1,000 board feet highs.
Lumber prices tend to peak during spring and summer as new home construction increases. The Fed’s pivot to a more dovish monetary approach could send mortgage rates down over the coming months, pushing lumber demand and prices higher.
Lumber proxies- WY, WOOD, and CUT have moved higher
On November 17, I highlighted three liquid products, one stock, and two ETFs that tend to move higher and lower with lumber.
- WY shares were at $31.92 on November 17 and have moved 7.9% higher to the $34.43 level on December 22.
- The CUT ETF, which closed at $30.90 on November 17, was 4.3% higher at $32.24 on December 22.
- The WOOD ETF settled at $76.75 on November 17 and rallied 6% to $81.35 per share on December 22.
Lumber proxies have moved higher with physical lumber futures since mid-November. The March contract rallied 6.2% from $551.50 to $585.50 since mid-November.
Illiquidity could exacerbate upside moves if rates start coming down
Physical lumber futures suffer from low volumes and open interest, causing prices to soar on rallies when offers to sell evaporate. Conversely, when lumber prices fall, bids to buy often disappear. Illiquid markets cause price gaps on the up and downsides.
If mortgage rates decline in 2024, pent-up demand for new homes could soar as the existing home supplies remain tight. Therefore, we could see a sudden surge in lumber prices in the coming year.
While the lumber futures market is the most direct route for risk positions, it is highly dangerous. The lumber proxies, WY, CUT, and WOOD, are the best bets for liquidity and exposure to wood prices in 2024.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
