LEONARD LUMBER REPORT: these fires are a real issue. We will see if they have any impact on our market.

Note: these fires are a real issue. We will see if they have any impact on our market.

We will start the commentary out with Commitment of Traders. It comes out for the Tuesday-to-Tuesday report, so it lags. Up until Tuesday, most of the trade was blowing out. The industry exited shorts and the funds exited longs. From Wednesday on, open interest started to grow again, with the guess being that the industry added longs while the funds added shorts.

What we continue to see time and again is the short funds getting out only to come roaring back. The fact that the housing market continues to tread water year after year is a contributing factor.

So let’s take a macro look at the economy in general and the trickle-down effect.

There are two opposing features to housing today. The first and greatest is the affordability issue. New and existing home prices are not coming off. At 6.5% and a Q2 median home price of 410,700, you have an overbuilt condition. At 5.5% and 350,000, you have an underbuilt condition. A 6.5% mortgage rate puts futures at 570. A 5.5% rate puts futures at 770.

We continue to be in this tremendously volatile situation. The market has been flat for a few years now, but the upside potential continues to grow.

Typically, a commodity will not stay below producers’ breakeven levels for long. The market is not seeing a steep decline in building activity; instead, construction remains relatively steady. With the announced shutdowns, we would expect producers to begin creating some upward momentum.

For the first time, we are seeing a more regionalized lumber market. Canada is dealing with production challenges as well as duties and fees, but its largest customer—the single-family housing sector—remains sluggish. It is the multifamily sector that is holding things together, and that market is supplied primarily by U.S. producers, who have the ability to add production and generally operate more efficiently.

As a result, the Canadian producer is facing a different set of fundamentals than the U.S. producer. That divergence is creating a market dynamic that has not been seen before. That is why we have two separate lumber contracts, because we have 2 separate markets. That is also why the spruce contract isn’t $700 on its way to $800. Pine is a substitute in many cases. 

Today, the raw data is straightforward: the futures market is trading at a deep discount to cash, and the RSI sits at 15.5%. Historically, these are the types of conditions where inventory is added through the futures contract.

With the funds selling once again, any recovery is unlikely to be a roaring rally. Instead, the market will probably have to work its way higher. That brings the $618 area back into focus as an important reference point.

The September roll is also approaching, and the associated buying could provide a modest tailwind to the upside. While it may not be enough to dramatically change the landscape, it could help support a rebound if the selling pressure from the funds begins to ease.

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