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You have come a long way baby

The lumber market has really come off the 2009 bottom of $140 per mbf and closed Friday at $399.80 per mbf on the back of good news out of the housing sector of the economy.


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The housing sector of the economy led the way in 2012 with record low interest rates, and investors and banks working through the foreclosed inventory, leading to a trending and steady rise in both average home prices and new constructions.


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Everything related to the housing sector performed well in 2012 from materials to the home improvement and remodeling big box retailers in Home Depot (NYSE:HD) and Lowe's Companies Incorporated (NYSE:LOW).


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Lumber prices getting slightly ahead of themselves?

But if we examine the history of lumber prices relative to the strength of the housing sector, lumber prices may be getting slightly ahead of themselves from a valuation standpoint.


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Lumber prices will probably break through the $400 level on trading momentum alone, but if we look at the charts most of the time lumber prices are south of the $400 level.


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The all-time high for lumber prices established in 1993 was just shy of $500 on a spike, with additional spikes of $440 in 1997, and $420 in 2005. So we are now basically sitting at $400 and in spike territory based upon the charts.


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I will be watching lumber for some additional upside momentum, and looking for a good entry on a longer term reversion to the mean short in the commodity as I think the risk and reward dynamics are setting up nicely in lumber for an eventual short once the momentum is exhausted.

Cheap capital chasing returns fueling the upside momentum

The U.S. economy is looking for all the good news it can get, and housing has definitely improved but lumber prices are pricing towards the best ever levels in the housing market from a comparison standpoint.


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I know that a lot of investment capital has moved into anything housing related seeking a return with a bunch of easy access to cheap capital.


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As a result prices can move well beyond historical valuation models, and I think they will definitely test the $420 and $440 levels as a direct result of liquidity flows.


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But from a historical valuation standpoint prices just do not stay for long at these elevated levels, and once the housing euphoria trade loses momentum, prices should fall more in line with historical norms around the $320 per mbf level.

Therefore, the higher prices get pushed up on the crowded investment spike this year, the better risk reward trading setup for shorting the lumber market in the future looking for a high probability reversion to the mean trade.

Source: Lumber Prices Near The Top Of Their Historical Range