Market Overview

Opportunity in Thinly Traded Lumber Market

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This post is from a series of featured articles pulled from a newsletter we are helping launch, The Commodity Analyst.  Originally sent to subscribers May 19th, we are sharing portions of the content a few days delayed here.  If you would like to see samples of the newsletter or subscribe to have it delivered each weekend in addition to ad-hoc trading recommendations mid-week, see here to sign up: http://realfinancenewsletter.com

The lumber market remains very volatile, but recent action has given indication of a bullish reversal.  We believe a long position in lumber may be attractive at recent prices.

Posted below is a chart of lumber against Managed Money net longs.

Lumber Managed Money Longs Chart

As can be seen, lumber is a very volatile commodity, and trading it is not for the faint of heart.  However, with great volatility comes great opportunity.

The chart shows that Managed Money basically controls the lumber market, with movements in Managed Money net long positions tracking very closely to price.  The current Managed Money net long position stands at +492 contracts, the lowest since August 2010.  From August 2010 until January 2011, lumber prices increased 66%, shown on the next chart.

Lumber Aggregated Open Interest Chart

This chart also shows aggregate open interest on lumber futures.  As can be seen, aggregate open interest dropped from a high of 12k to stabilizing at 10k.  However, even after stabilizing at 10k, the price of lumber continued to drop precipitously.  This would seem to suggest that the beginnings of the decline were caused by long liquidation, and then the rest of the decline may have been caused by new shorts entering the market.  The chart of Managed Money total short contracts posted below reflects this logic exactly.

Lumber Managed Money Shorts Chart

As can be seen, Managed Money short positions on lumber skyrocketed in April and May, coinciding exactly with the stabilization of aggregate open interest and price drop.  The last time shorts got this high was in August 2010, and, again, lumber rallied 66% in the 4 months thereafter.

Fundamentals

Last week's housing starts numbers and this week's existing home sales numbers were terrible.  Housing starts, expected to be at +3.6%, actually came in at -10.6%.  Existing home sales were -0.8% instead of the expected +2.0%.  Both of these numbers should have been extremely bearish for lumber, since the primary use of lumber is in construction.  However, the market's bullish reaction is telling.

After the release of today's bearish existing home numbers, lumber has actually rallied2.45% to $230.  This indicates that there may be such a preponderance of short sellers in the market that lumber's downside is capped, as there are few willing long liquidators at these prices and many short sellers who need to buy to cover.

We believe that as short sellers cover their short positions, (and hopefully the economy continues to show modest improvement) lumber prices will rebound due to the preponderance of buying.

Trade Recommendation
We recommend the purchase of lumber at a price of $230 or better.  We would view upside on this trade of at least 15-20% given how many short sellers are in the market.  Downside support would most likely come in at the psychologically important $200 level.  Please note that this trade is volatile and slightly illiquid as the lumber market is a thin commodity market, so size positions accordingly.

ALL INFORMATION INCLUDED HEREIN IS THE OPINION OF THE FIRM AND SHOULD NOT BE CONSIDERED INVESTMENT ADVICE. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

 

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

 

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