Lumber- Another Clue In Understanding The Economy

I find three natural resource markets helpful in assessing the state of the global economy. Price action in copper often yields important clues as to the strength of infrastructure building around the world, particularly in China. Crude oil is the world's most important energy commodity. While the bulk of supplies come from a very turbulent region in the world, the Middle East, demand is ubiquitous.

Another commodity that I like to watch for economic clues is lumber.

Lumber is a natural resource that is required by the housing and construction industries in the United States and around the world. The U.S. government issues a report on the number of newly built homes each month. This report tends to move many markets, none more than the price of lumber futures. The lumber market often knows the results of the government report before issued, as lumber is a key component in home building. During a boom time in home building, demand for lumber tends to increase. As home building decreases, demand for this important commodity tends to fall. The lumber market has long been a crucible for trends in home building and the general economic condition.

The United States is the world's top producer of timber, followed by India, China, Brazil, Canada, Russia and Indonesia. China is the largest importer of soft wood lumber, over recent years unprecedented growth in the Asian nation has required more of this important building material.

Lumber futures and options contracts trade on the Chicago Mercantile Exchange (CME). There is a physical delivery mechanism for the CME contract. Each futures contract represents 110,000 board feet of lumber. The exchange, in coordination with the lumber industry in the United States and Canada, sets delivery specifications for lumber.

As of mid November 2015, lumber was trading at $243 per thousand board feet.

Lumber traded at all-time highs of $493.50 per thousand board feet in January 1993. The lowest price of lumber on the CME was $94.60 in October 1974. Since 2013, when lumber traded to highs of $398, the price of this commodity has moved lower. The global economic slowdown and issues surrounding declining growth in China have caused demand for the commodity to decrease.

Lumber is not a particularly liquid futures contract. While business in the underlying physical lumber business is active, futures have never provided the liquidity necessary to attract investors and speculators. In November 2015, the total open interest in CME lumber futures was under 4,000 contracts. Open interest is the total number of open long and short positions on a futures contract. While a commodity like NYMEX crude oil had all-time high open interest of around 1.86 million contracts and COMEX copper peaked at 180,000 contracts, lumber open interest only peaked at around 14,400 contracts. Additionally, on most days, lumber trades less than 1,000 contracts of total volume. These metrics make lumber futures a market that is more useful as a tool for benchmark pricing rather than for hedging, investing or speculating.

Meanwhile, the price of lumber is an important informational tool for those interested in understanding macro economic trends. In 2015, the price of CME lumber has traded in a range between around $330 and $214 per thousand board feet. The highs came at the beginning of the year and the lows at the end of the third quarter. At the lows, lumber traded to the lowest price since December 2011, which was reflective of weak economic conditions around the world and more particularly in China.

Lumber is an important commodity to watch as it can tell us a lot about the overall demand for raw material markets around the world. In 2015, lumber has been reflective of weak global economic conditions. If you consider investing in or trading lumber, be careful. Illiquid markets like lumber are often highly volatile and tend to gap higher or lower with very little volume.

For investors, there are also two ETF products available. CUT, the Guggenheim Timber ETF, has net assets of around $175 million and an expense ratio of 0.70%. WOOD, the iShares Global Timber and Forestry ETF, has net assets of around $220 million and an expense ratio of 0.47%. Both products correlate with the price of lumber futures and offer a less volatile way to position in the lumber market.