In an April 26 Barchart article, “How is the New Physical Lumber Contract Doing,” I highlighted the total number of open long and short positions, or open interest, in the old random-length contract and the physical contract replacement. On April 25, open interest in the new physical lumber futures contract stood at 3,794 contracts, and the metric in the random length futures had declined to 708 contracts.
Since then, the old 110,000 board feet contract disappeared, while the open interest in the physical lumber futures has increased. Meanwhile, the price action has been sleepy, with physical lumber futures hovering around $500 per 1,000 board feet.
Open interest continues to rise
The total number of open long and short positions in the CME’s smaller and more flexible physical lumber contract has increased over the past weeks.
As the chart highlights, open interest in the active month July physical lumber futures contract increased from 1,826 contracts on April 25 to 4,741 on May 16.
The metric in the September contract moved higher from 296 to 1,043 contracts over the period.
The metric increased as the random length contract ceased trading.
The price is going nowhere fast
In 2023, physical lumber futures have traded in a narrow range.
The chart of July futures shows a 2023 low at $485 and a high of $652.50 per 1,000 board feet. Since late March, physical lumber futures have traded between $496.50 and $551.50 per 1,000 board feet.
The 2023 range is narrow, considering the random-length contract fell to $251.50 in April 2020 and rose to $1,711.20 in May 2021 and $1,477.40 per 1,000 board feet in March 2022.
Rising U.S. interest rates translating to skyrocketing mortgage rates caused the demand for new homes to decline. Lumber is a main ingredient in homebuilding.
Economic data says rate hikes are done
The U.S. central bank increased the short-term Fed Funds Rate from zero to 5.125% from March 2022 through May 2023. Moreover, quantitative tightening at a rate of $95 billion monthly pushed rates higher further out along the yield curve. A conventional thirty-year fixed-rate mortgage moved from below 3% in late 2021 to over 7%. The monthly increase on a $400,000 lean amounts to more than $1,300, limiting the demand for new homes.
Meanwhile, the latest April consumer and producer price index data showed that inflation is subsiding. While still far above the Fed’s 2% target level, the trend will likely cause the central bank to pause its rate hikes. Moreover, the Fed Funds Rate is now at the Fed’s 5.125% 2023 target level.
Increasing rates takes time to filter through the economy, and the central bank will likely pause and watch as its tight monetary policy over the past year continues to erode inflation. The bottom line is the data favors no further rate increases in 2023. As consumers adjust their expectations to the new environment, the demand for new homes could begin to edge higher. Moreover, migration from high-tax to low-tax states could increase new home construction on a regional basis.
Seasonal highs in the spring, but do not expect any significant rally in 2023
Lumber futures tend to reach seasonal highs in the spring. The 1993 high in the random-length lumber futures came in March, and the 2021 record peak was in May, while the 2022 high occurred in March. The weather during spring tends to support construction projects.
Meanwhile, at the $500 per 1,000 board feet level on May 18, the price continues to reflect a rate environment that does not support higher lumber prices. However, the $500 level is higher than the pre-2017 peak in the random-length lumber market.
As the market adjusts to more restrictive monetary policy, the demand could increase over the coming years. The 2024 spring season could see a rise in lumber demand, meaning the market may need a year of consolidation to break out of the current trading range.
Three assets that follow lumber prices- WOOD, CUT, and WY
The most direct route for a risk position in lumber is via the CME’s physical lumber futures contracts.
The forward curve reflects a contango, or progressive higher prices each contract month to July 2024.
Three assets tend to follow volatile lumber prices, underperforming the futures on the upside but outperforming when the futures decline:
- WOOD is the iShares Global Timber & Forestry ETF product. At $71.99 per share on May 17, WOOD had over $203 million in assets under management. WOOD trades an average of 12,075 shares daily and charges a 0.40% management fee. WOOD holds shares of the top lumber-related companies trading on the stock market. The $1.64 annual dividend translates to a 2.28% yield.
- CUT is the Invesco MSCI Global Timber ETF that owns shares of the leading wood-related companies. At $29.41 per share on May 17, CUT had nearly $59 million in assets under management. CUT trades an average of 2,720 shares daily and charges a 0.60% management fee. The $0.78 annual dividend translates to a 2.65% yield.
- Weyerhaeuser Company (WY) operates as a real estate investment trust with exposure to lumber. At $29.48 per share on May 17, WY had over $21.4 billion in assets under management. WY trades an average of over 4.20 million shares daily. The $0.76 annual dividend translates to a 2.58% yield.
WOOD, CUT, and WY have exposure to lumber prices, so the shares will likely reflect price action in the lumber futures arena. While the open interest has increased, the futures market remains more of a benchmark to watch than an asset to trade. Lumber futures remain illiquid, and time will tell if the new physical contracts attract the volume and open interest required to make them attractive trading, hedging, and investment vehicles.
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