Is Lumber Going to Rally?

Lumber is a critical infrastructure building block. While wood is a crucial industrial commodity like oil, copper, and other energy and metals, the lumber futures market is far less liquid than the other industrial raw materials. Low liquidity creates challenging trading conditions as bids to purchase often disappear during selloffs and offers to sell can disappear when the price rises. Illiquidity tends to lead to hyper price variance.

Over the past years, lumber prices have spiked to over $1,700 per 1,000 board feet in 2021 and under $355 in early 2023. The extreme price swings encourage traders and speculators to avoid the lumber futures arena like the plague. The Chicago Mercantile Exchange attempted to increase liquidity by abandoning the de-listed random-length lumber futures contract and replacing it with the current physical lumber contract. The new listing has a smaller contract size, broader specifications, and more delivery flexibility. However, the leading metrics determining liquidity, open interest, and volume have not improved. Therefore, lumber prices remain highly susceptible to wild price swings when trends develop.

Lumber prices have remained stable at around $500 per 1,000 board feet, and the market is now in the off-demand season as construction projects slow during winter. Meanwhile, action in other markets and other factors could lift wood demand over the coming months, igniting the illiquid market.

I would never trade a lumber futures contract as low liquidity dramatically increases risks. However, there are lumber-related products that offer liquidity and tend to move higher and lower with wood futures prices.

Lumber prices are steady in late 2024

• Nearby physical lumber futures prices have traded in a narrow $193 range in 2024, from $418.50 to $611.50 per 1,000 board feet.
• At the $599 level in mid-November 2024, lumber futures are near the top end of the trading range.
• The winter is the offseason for construction demand, and lumber is a critical ingredient for builders.

Short-term interest rates are falling- Will long-term rates follow?

• The Fed cut the Fed Funds Rate by 50 basis points at the September FOMC meeting and another 25 basis points at the November 6 meeting.
• Fed guidance indicates another at least 25 basis point reduction by the end of 2024 and 100 points lower in 2025 as inflation approaches the central bank’s 2% target.
• Longer-term interest rates have moved higher despite the Fed’s short-term monetary policy easing.
• S. debt, geopolitical turmoil, and U.S. political events have caused the U.S. government’s 30-year Treasury bond futures to fall and interest rates to rise since September 2024 despite the Fed Funds Rate decline.

Mortgage rates are crucial for the path of least resistance of lumber prices

• Lumber is a crucial ingredient in new home construction.
• High interest rates have weighed on housing and lumber demand over the past years.
• As monetary policy continues to ease over the coming months, a rise in the U.S. bond market that caused mortgage rates to decline could increase the demand for new home building and lumber.
• Existing homeowners with sub-4% mortgages will limit existing home sales, keeping the housing market tight.
• Pent-up demand for homes could put upward pressure on lumber demand and prices.
• Government building projects and new home demand could ignite lumber prices in 2025. 

Levels to watch in the lumber futures arena

• Technical support in the physical lumber futures market is at the 2024 $418.50 per 1,000 board feet low.
• Technical resistance in the physical lumber futures market is at the 2024 $611.50 per 1,000 board feet high.
• Low liquidity in the lumber futures market could cause offers to sell to evaporate on a rally or bids to buy to disappear during selloffs. Illiquidity in futures markets tends to exacerbate price variance.

ETFs and stocks that tend to follow the lumber futures market

• Low liquidity in lumber futures makes them untradeable.
• The iShares Global Timber and Forestry ETF (WOOD) tends to track lumber prices.
• The Invesco MSCI Global Timber ETF (CUT) tends to move higher and lower with lumber futures prices.
• Weyerhaeuser Company (WY) operates as a REIT (real estate investment trust), owning and leasing timberlands in the U.S. and Canada. WY shares are highly sensitive to lumber prices.

The monthly chart shows lumber futures’ penchant for extreme price variance and its recent price consolidation. Pent-up demand for new homes, and the potential for falling mortgage rates over the coming months could push lumber prices significantly higher. Lumber is a seasonal commodity that tends to reach annual highs during the spring construction season. Adding some lumber exposure to portfolios during winter on a scale-down basis could be optimal for 2025.

Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!