LEONARD LUMBER REPORT: It was another brutal week for prices

Recap:

It was another brutal week for prices as both cash and futures continued to unwind. On Wednesday and Thursday, we saw a pickup in selling from the funds into the November contract. That is not typical. Short funds do roll to the second month, but they normally do not add to positions before the front-month expiration.

So, what has changed? Most likely, the funds have started to rebuild from an extremely low position back toward full exposure. Total open interest climbed from 6,000 to 10,300 in a matter of weeks. This has been an extreme reversal and raises the open question of just how short they want to be. Is the target 6,000 shorts, 8,000 shorts, or even more?

So why all the discussion about the risk coming from a non-industry factor? Because the funds are driving the market. Price does not. Supply does not. The funds do. Over the long run, price, the economy, and supply and demand will take the lead. But when positions are being built or liquidated, those flows become the primary drivers.

For the industry, the timing is nearly impossible, but the data carries a great deal of weight. Many have bought futures and cash at levels that should prove profitable during this selloff, yet they are now showing up as done far too early. Did they maximize profits? No. But no one can factor fund momentum into otherwise sound market analysis. It only becomes visible in hindsight, when you discover you were either too early or too late.

This week, the cost of production and mounting mill losses will once again work its way into the conversation. While it may seem like a micro issue, it is a market driver across all commodities. Ultimately, it will force the market to find a trading level while the industry attempts to rebalance once again.

The timeline is relatively straightforward. The market will first determine whether the funds are moving from 6,000 shorts toward 8,000. At this point, there is little reason to expect them to pause. If they continue to build positions aggressively, futures could test the $500 level. If the pace of selling begins to slow, futures should work back toward the $580–$600 trading range, which has served as the market’s median value area for years.

Technical:

The futures market is extremely oversold. Probably much more than the data shows. November corrected Friday to 19.3% or a 2 to 1 rate of change. I don’t want to get into the weeds on this one because there is more undue pressure added to the futures side. Oscillators don’t cover this very well. The market has been sitting oversold all of August. The next push lower could create a sharp upward correction. Until then, messy is the best way to sum it up.

Daily Bulletin: