LEONARD LUMBER REPORT: The one feature of the week was computer-like selling

Week Recap:

The November futures fell $33 on light volume. The one feature of the week was computer-like selling in most sessions after expiration. What became apparent was that the pre-expiration rally was liquidation-driven. Once that was complete, the downward trend continued. Open interest fell by about 800 contracts. November futures are now down $120 in 43 sessions.

Market make up:

The producer side has 5,305 longs in place and 439 shorts. Yes, the industry is not short. The funds are short 6,066 contracts. We see a limit to how many shorts they are willing to carry, so much of the selling late in the week was most likely algorithmic in nature. We are also seeing a marked pickup in swap trades for this contract.

I would note that open interest remains high despite the lack of trade. There is no discount and no premium. Today, the only thing being offered is cheap and cheaper. There will be a rather large roll. The question is where it starts from.

Funds:

The funds remain very difficult to track. We know that interest rates, the dollar, and other economic factors all play into the equation. What we do not know is how they are positioned in other commodities, nor do we know their true capacity. The futures market rallied to $660 because they were exiting positions and fell to $536 on Friday because they continued to add shorts.

In trading-floor lingo, we blew them out, and now they are back with a vengeance.

Summary:

The discussion around the funds has little to do with why November futures settled at $537. The market settled at new lows because the housing market is sputtering just as mills are ramping production back up following summer shutdowns. Over the last few years, demand has remained relatively consistent. I believe the healthy premium in the futures market encouraged buyers to step up more aggressively than necessary. Today, that advantage is gone, leaving buyers strictly hand-to-mouth. Add a modest increase in post-shutdown supply, and the result is an imbalance. There is little appetite for risk in this environment. The trade will buy when it needs wood, and it does not matter if they have to pay up. At this point you have to create value in the futures market by going to a premium or discount. That could take time.