Lumber Is Parabolic and Natural Gas Is in Contango

We've opted to kill two birds with one stone with this week's commentary. We are receiving a plethora of questions regarding the lumber rally and almost as many on the recent run in natural gas. Here are our thoughts. Lumber futures have gone parabolic, but that probably won't last Lumber futures are in the midst of a historical rally on the heels of a surprisingly hot housing market. I doubt anybody predicted this in March of 2020 but the surprise element is likely what has been a driving force to the rally. Further, lumber futures are known for a lack of liquidity which can cause price moves to become exaggerated as motivated market participants panic. Several years ago, when commodities traded in pits, I recall walking by the lumber pit on my first trip to the trading floor. I was shocked to witness the lumber pit was merely a few guys reading newspapers while waiting for orders to come in. Even with the advent of electronic execution, liquidity hasn't improved much. The front-month contract, November, had traded less than 300 futures contracts by mid-day. Not surprisingly, the option market is a ghost town leaving speculators and hedgers with few options to manage risk. There is plenty of risk to be had in trading lumber futures. Each full point is worth $110, and we are seeing daily moves of $20 to $30 per board foot, or $2,200 to $3,300 to a trader. Nevertheless, parabolic commodities rarely stay that way for long because the supply chain adjusts for market demand and high pricing. If you are looking to go long lumber, you have probably missed the boat. If you are looking to go short, you had better have nerves of steel and plenty of margin. A retest of $830 on the November contract is possible but a correction could see prices as deep as $550 to $500. To put this into perspective, a retest of $830 from here represents $11,000 to a trader and a fall to $550 would equate to nearly $20,000. On a side note, the September contract is trading above $900 but it is in the delivery and expiration process, and should no longer be traded. Source: QST Pay attention to the contango in natural gas Hotter than expected weather, a weaker dollar, and a general theme of firm commodity prices have enabled natural gas futures to climb higher despite an oversupply backdrop. However, while the front-month contract is still trading in the mid-$2.00s the back months seem to already be pricing in a winter premium. For instance, the December natural gas futures are hovering near $3.25, about 70 cents higher than the October futures contract. In our view, this suggests the rally could stall as traders regroup from the summer weather rally and continue to plan for the upcoming winter. Ironically, the natural gas market often declines during the early winter months because much of the increased consumer demand for heating is accounted for in advance. In most years, the natural gas weather premium is built into pricing in the fall but this year the seasonal run-up appears to have come early. If so, natural gas prices could struggle to hold gains. Because futures contracts expire, when looking at a weekly or monthly chart, what you see isn't always what you get. This is because long-term charts must combine data from separate contract expiration months and that leaves some room for misinterpretation. For instance, the continuous weekly chart of natural gas I use for analysis is based on the front-month contract, which requires us to read between the lines. We have mapped out what we deem the comfort zone in natural gas pricing between $2.50 and $3.50. The front-month contract (October) has slightly entered the comfort zone but the back-months are in the middle-to-upper section of the zone. In short, the recent rally has put prices into what we have charted as the comfort zone and will likely see upside momentum wane sooner rather than later. We expect prices to dribble lower in the coming weeks. Source: QST *THERE IS A SUBSTANTIAL RISK OF FINANCIAL LOSS IN TRADING FUTURES AND OPTIONS.

Lumber Is Parabolic and Natural Gas Is in Contango

Here's our take on the rally in lumber and the recent run in natural gas.

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