Seeking Alpha

Lumber Starts To Move

About: iShares S&P Global Timber & Forestry Index ETF (WOOD), Includes: CUT, HOML, HOMZ, ITB, MORL, MORT, NAIL, PKB, REM, XHB
by: Andrew Hecht

Probing above $400 per 1,000 board feet.

The Fed meeting provided guidance.

Forget about lumber futures.

The 2020 election could encourage new home buying.

WOOD is a diversified product.

Lumber is a volatile and illiquid commodity that trades on the futures exchange. While trading lumber is virtually impossible because of the lack of liquidity, it is a bellwether industrial market. Lumber is an essential material when it comes to building and construction. The price of lumber reflects the overall condition of the market for new homes across the United States.

In September 2015, the price of lumber fell to a low at $214.40 per 1,000 board feet. Many other industrial commodities declined to significant bottoms in late 2015 and early 2015. The price of copper reached a low of $1.9355 per pound in January 2016. Crude oil, the energy commodity that powers the world, hit rock bottom at $26.05 per barrel in February 2016.

Since then, the prices of almost all commodities have recovered. The move to the upside in the lumber market was downright explosive. The previous all-time high in the lumber market was in 1993 at $493.50 per 1,000 board feet. By May 2018, the price of wood blew through the 1993 high as a hot knife goes through butter when it rose to a peak at $659 per 1,000 board feet.

Gravity hit the lumber market in the months that followed. By last October, the price of lumber futures fell to just under $300, over half the price level in only five months. In May 2019, lumber found a bottom at $286.10 per 1,000 board feet. Since then, the price of random length lumber futures has been moving to the upside. Last week the price rose above the $400 level. While lumber is a challenging futures market when it comes to trading or investments, the iShares Global Timber and Forestry ETF product (WOOD) is liquid. WOOD moves higher and lower with the price of lumber.

Probing above $400 per 1,000 board feet

As we head into the winter season, the demand for construction materials typically declines. Meanwhile, the lumber futures market has displayed signs of life over the past weeks.

Since May 2018, lumber futures had made lower highs, but the price is now rising to a level that threatens to negate the bearish price pattern in the wood market.

Source: CQG

The weekly chart shows that after trading to $659 per 1,000 board feet in May 2018, lumber made a lower high at $453.90 in February 2019. In mid-June, the high at $413.60 was at a lower level.

Last week the price was back above the $400 level as lumber futures have made higher lower over the most recent months. Price momentum and relative strength metrics have been gently rising above neutral territory. The rally has been slow and steady, so weekly historical volatility has dropped from over 65% in August to 23.38% at the end of last week. Open interest, the total number of open long and short positions in the lumber futures market has started to turn higher and was at just over the 3,100-contract level at the end of last week.

The metric had dropped to a low at under 2,000 contracts in September. Rising price and increasing open interest is typically a validation of a bullish price trend in a futures market. Nearby November lumber futures traded to a high of $409.40 per 1,000 board feet recently, which was the highest price since early July. The price of wood was closing in on the mid-June high at $413.60, which is the first level of technical resistance. A move above the June peak would negate the bearish price pattern that has been in place since May 2018.

The Fed meeting provided guidance

The October 30 meeting of the FOMC could have a significant impact on the price of lumber futures over the coming weeks. The Fed cut the Fed Funds rate by 25 basis points for the third time since July 31.

The Fed decision last week is likely to impact the price of lumber. Lower rates in the US will push the cost of 30-Year fixed-rate mortgages lower, which stimulates the market for new home purchases. Rising demand for new homes increases the requirements for lumber, which is an essential construction material.

The Fed guided the lumber market last week, and the price of lumber could be in a position to move higher over the coming months.

Forget about lumber futures

Lumber futures are not tradeable. Futures markets that suffer from a low level of liquidity often suffer from price gaps that make stops more than a challenge.

Source: CQG

As the daily chart of the now active month January lumber futures contract illustrates, open interest was at 3,113 contracts at the end of last week. As a comparison, crude oil open interest was at 2.048 million, and copper futures had a total of over 238,500 contracts as of October 31. During an average session, fewer than 500 lumber contracts change hands. However, in a bullish sign for the lumber market, open interest had been rising since the beginning of October, and volume on Friday, October 25, was 1,112 contracts. When the volume and open interest rise with the price, it is often a bullish sign for a futures market.

The 2020 election could encourage new home buying

The 2020 Presidential election in the United States is now a little over one year away. The uncertainty of the political landscape as a result of the election could accelerate new home purchases in 2020. The current level of interest rates is historically low. With 30-Year fixed-rate mortgages at 4% or lower, there may not be much room on the downside for rates to fall in the US, but they are not rising, which is bullish for new home building. Moreover, home prices in some areas of the country have been declining, creating some bargains for buyers who have waited for a dip in the housing market.

At the same time, the future of tax policies in the US could prompt some buyers to come back to the market. The tax cuts under the Trump Administration limited some of the benefits of homeownership when it comes to mortgage and local property tax deductibility. Changes in those policies under a new administration in 2021 could cause some buyers to consider new home purchases over the coming year.

The bottom line is that rates are at such a low level in the US that we could see home buyers who have been waiting for an opportunity to purchase a new home pull the trigger. Additionally, any movement towards an infrastructure rebuilding program in the US would increase demand for lumber, which is a building block of any construction project.

WOOD is a diversified product

The lumber futures market is a benchmark for pricing. However, it is not a trading or investment vehicle because of the low level of volume and open interest. Fortunately, some products and companies reflect changes in the price of wood that are liquid. Companies like Weyerhaeuser (WY) and the CatchMark Timber Trust (CTT) are real estate investment trusts that own and lease timberlands in the US and Canada. The shares of both company's move higher and lower with the price of lumber futures and both pay dividends of over 4%.

The iShares Global Timber and Forestry ETF product owns shares in companies that are involved in the lumber business, including WY. The most recent top holdings of WOOD include:

Source: Yahoo Finance

WOOD has net assets of $217.47 million, trades an average of 24,629 shares each day, and charges an expense ratio of 0.46%. At the same time, WOOD has a yield of 3.30% given the dividends paid by the companies held by the ETF. The price of lumber moved from a low at $286.10 during the week of May 28 to a high at $409.40 recently, a rise of 43.1%.

Source: Yahoo Finance

The chart shows that WOOD appreciated from $54.33 on May 31 to $64.18 at the end of last week, a rise of 18.1%. WOOD and other lumber-related stocks tend to underperform the volatile lumber futures market on the upside and outperform the futures on the downside.

Lumber has been making upside progress since the summer. The next level to watch on the upside is the mid-June high at $413.60. Above there, $453.90 per 1,000 board feet is the next level of technical resistance.

Lower interest rates and a pickup in new home building would support the price of lumber. WOOD and other lumber related products would benefit from higher lumber prices over the coming weeks and months.

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.