Category: Hedging

It was a tough week with tough weather. The result was a flat trade. Over the past few weeks, we have seen a sizable contraction in open interest. Last week we saw a tepid trading volume. The whole structure seems to be looking for the next move to react to. There is no preplanning in the works. With that, the next play is to measure the marketplace pulse. The fact is if tomorrow you need wood, the cost is substantially higher than the last purchase. The “wait it will come down” strategy isn’t going to work on this one. Created momentum will carry the market much higher. That is the standard industry reaction. In the interim, the market volume allows for a 585-605 trade. Add some volume and it could be 580 to 620. I would suggest that the trade could stay flat for a while, but that seldom is the case.

What is contributing to the pulse today?

The Fed pick was a positive. He will add to the dialog and rely less on old data. In a backdoor way, he could add to an uptick in commodity inflation.

Another contributing factor is the imbalance of the current market. The industry has wood that is not leaving the yard. As it goes out, the replacement costs are going up. That fact alone keeps the second buy, or really the first of the new year at bay. The 90-day inventory will be 30 days overnight, creating a problem.

Finally, and most important is the fact that we haven’t seen a demand uptick yet seasonally. We have created an atmosphere of “no business” after years of no business. Reports project a slight Q1 increase. That will be the case unless there is an economic issue. The BBB is actually adding some positive helping the overall strength. It’s a mistake get too negative on housing Q1.

Technical:

We have to take a small ball approach to this trade. There is a gap from 608.50 to 610. That will be the objective on any positive momentum. The downside has a little more. The first is a good trendline coming in at 592.00. We are there. Let’s see where we close. The other is the 200-week moving average coming in at 563.60. The fact that the short funds are exiting already, and the low volume keeps the algo trade away, I’m not looking for that type of move. That said, it is a good guideline to keep a percentage hedged. You never lose money hedging.

Daily Bulletin:

https://www.cmegroup.com/daily_bulletin/current/Section23_Lumber_Options.pdf

Southern Yellow Pine:

https://www.cmegroup.com/markets/agriculture/lumber-and-softs/southern-yellow-pine.volume.html

The Commitment of Traders:

https://www.cftc.gov/dea/futures/other_lf.htm

About the Leonard Report:

The Leonard Lumber Report is a column that focuses on the lumber futures market’s highs and lows and everything else in between. Our very own, Brian Leonard, risk analyst, will provide weekly commentary on the industry’s wood product sectors.

“Doing the same thing over and over and expecting different results,” Albert Einstein. He must have been talking about the lumber trade. What we just saw was an outside influence causing a sharp increase in prices over a period of time, only to reverse most of it overnight. March futures rallied $64.50 off the mill fire over a 10-day period. It gave back 61% in 2. The trade didn’t hedge because they were already Texas hedged (long futures and long cash). The spec community added to their positions on the way down. The trade was looking for this one to be it. It still very well might be, but the market still has a demand issue.

The momentum is positive. There is a much greater push to the upside. That will remain in place under the current dynamics. The fact that you can’t wait and buy cheap will keep the buy side off balance. Add to it the lack of basis, which took some of the risk out, is no longer available. Last year, you bought low, and it went lower. This year, you will have to pay up, making timing and hedging key. To sum it up, you will pay more for lumber in 2026, and a $30 basis may be all you can get.

Technical:

The 61% retracement up this upswing in 578.80. That was also an old support area. No one would disagree that a pullback to that area wasn’t healthy. The issue is that it occurred in a single session. Is that a correction or a warning of rough seas ahead?  A long-term bear cycle will not end that easily. This last bear wave went sideways for 6 weeks before the fire bottomed it. That’s not a traditional bottom. This is a seasonal bull cycle, so the yin and yang are in overdrive.

A trade back to 578.50 could trigger selling for all sides. That hasn’t changed yet. On the flip side, the market only needs to close over 608.50 to bring back supportive indicators.

50 bucks on a fire. That is what March rallied last week on news of the mill fire. The reduction in supply over the last month has been a worry for the industry. The fire served as the catalyst for all the purchasing we saw. We come into the week with a watchful eye on the pace of cash buying. This run has been entirely cash driven. It will need to see follow-through to help the already premium futures market. The issue here is the time of the year. We have been pretty committed to the seasonals for a good 14 months now, and have to deal with a winter event. The below-freezing temps will stop the process. Any signs of a slowdown in cash will send the longs in futures to the sidelines. It will also slow the spec community from continuing the upward pressure. This could be short-lived if the pipeline is as thin as is getting reported. So there are two questions to be asked:

• Has the recent buying filled the hole?

• Can the speculators pick up their pace to offset a flat cash trade?

March open interest is coming off as traders take profits. With 7000 industry longs, there is still a large chunk to take profits. I hope they don’t head to the exits at once.

Technical:

There are 7000 industry longs and 6300 fund shorts. Fundamentals favor the longs, but the size of both will definitely bring in volatility. For the first time in a while, futures are looking top-heavy. At 75.30% RSI, there is more room to the upside. The issue is that the quick run up extends the oscillators quicker than the RSI. 2025 March had the same technical read. It gave up a little going into the end of Jan and then took off to new highs. A continuation pattern will show up on Tuesday if it is still in place.

We are not reversing out of the uptrend. We expect some type of correction.

Recap:

Light at the end of the tunnel. After 14 sessions in the same range, the bleeding may have slowed for now. The longer the market goes without a buy, the closer it gets to one. This year, each buy was triggered by some type of announcement. For the remainder, the buy side picked off deals. Last week, January futures were only down $4.50 after experiencing a $27.50 range for the week. During that period, open interest increased to 10,500. Interestingly, the CFTC report is gradually catching up, showing a rise in fund shorts on October 28. My belief all along is that the funds are holding many more shorts on this one than in most past years. This indicates that the funds are aggressive on the downside and will roll, staying short. They have been correct for several years. That roll should become evident soon, especially as the holidays shorten trading this month. Low volume could lead to rallies off the roll.

This year, the market never had a sustained rally. So why is that? Why has the marketplace held sufficient inventories all year long? We are underbuilt, correct? Supply is getting reduced monthly, and demand remains steady. That has led to spikes, followed by selloffs of a greater magnitude. The market is acting as if the normal factors leading the market are changing. I have touched upon “outside factors,” maybe generating a different-looking housing market. I like the term “great reset.” It isn’t a new development in the industry but rather a reset or return to a former norm. So, what is the new norm? Extremely low rates allowed many to buy up relative to their earnings. Then you had COVID, which chased many, including me, to a safer environment. Today, it appears more like the older market, where the buyer’s reasoning or budget doesn’t prompt them to move. Have the newer factors changed, dynamics? Or maybe resetting. If true, the market will see A. more inventories show up as rates lower. Those sellers are not necessarily buyers of new homes under these circumstances. The buyers will start to see a normal 3-5% return on their homes, slowing their ability to trade up. And finally, more families will be choosing a forever home and not the “next step up” home.

There is a real demand issue in our market. Less supply will help prices, but the overall business is down and just may stay there. We have the BBB coming on Jan 1 to help some, but there could just be a shift in buying a home back to the norm.

Technical:

Last week’s points were 554.20, 556.70, and 562.50. Those are still in play. The chart pattern is a bottoming formation. The roll and year-end could help create a buy push. This has been a year of scaled-in selling. Always being early has been a good thing. It looks as if the $70 basis could now be a $50 basis. Again, reverting back to the norm…. It has been about 2 months since the market pushed through the 13-day EMA. It sits at 544.40. Last Thursday’s spike traded through it but then closed lower. Let’s see if the January futures will test it this week.

Daily Bulletin:

https://www.cmegroup.com/daily_bulletin/current/Section23_Lumber_Options.pdf

Southern Yellow Pine:

https://www.cmegroup.com/markets/agriculture/lumber-and-softs/southern-yellow-pine.volume.html

The Commitment of Traders:

https://www.cftc.gov/dea/futures/other_lf.htm

Recap:

This market remains challenging. Last week, futures hit new lows almost every day, with all focus on the daily EFP deals. Most of the cash trades occurred at one mill, forcing the others to work hard to find value. This type of trade signals a bear market that is likely to continue. Throughout the year, the market has rallied because of the duties and tariffs, but without an increase in demand. Supply is tightening, but not at a pace to boost prices. We are waiting for signs of that scarcity. While we wait, there’s a large gap between the November expiration price and the January contract. These gaps are filled, but recent history shows it usually happens near expiration. The market typically gets a relief bounce before setting the lows. The issue today is the timing. We’re heading into a quiet period through Thanksgiving. We’ll see if the trade hibernates until then.

Technical:

Not that my writing isn’t confusing enough, I’ll try to beat it this time. There is a gap left from the September 2024 expiration from 499.50 to 493.00. Last week’s low was 496.00. That gap is finally getting closed. The elephant in the room is that now we have the Nov expiration gap and the older gap hanging over the market. The January contract settled on Friday at 560.50 with an RSI of 19.97%. Two takeaways: you can’t sell the January here, but your inventory is at a substantial risk over time. Macro: Hedge at $60, $80, and $100. Micro: When demand catches up, buyers will have PTSD thinking it is 2021 again. Buy cash or hedge.

This is the first time in many years that the risk is so evenly matched. There is a possibility of a $100 move in either direction. Hedge your risk! Your hedging dollars, if wrong, will be pennies per truck. If you don’t hedge and you are wrong, it will be bitcoins per truck. Hedging is a cost of doing business. Hedging is a medical insurance policy. Hedging is a production builder. For the mills, hedging is a paying customer who pays the next day. Hedge your risk and sleep better.