Lumber Contango Spells Economic Rebound

Copper used to be said to be the metal with "a PhD in economics".  But lately, copper is just a doppelganger for whatever stock prices do.  Now, the commodity that really tells us about the economy is lumber. 

Lumber is unique among industrial commodities in terms of the balance that its prices portray about the conflict between supply and demand.  Ups and downs in the housing market affect demand for lumber.  But the input costs also vary according to the availability of raw timber, labor costs, electricity to run the mills, fuel to transport it, and space to store it.  It lies at the crossroads of a complex set of economic forces.

I believe that is what makes it such a great economic indicator, as detailed in the articles referenced below.  And that makes the recent decline in lumber prices a bad omen for the near term future of the economy.  But within that decline, there is deeper information about what lies ahead in the more distant future.

The near month contract as of Oct. 7, 2011 is the November contract, which as I write this stands at 226.60.  If we go out almost a year to the Sep. 2012 contract, it stands at 280.10.  That is a pretty big spread, as shown in this week's chart.

When the near month contract is well below that of several months out, it is a condition known as "contango".  A higher price in the distant month futures contracts is a sign that spot and near month contract prices are likely to rise.  It is also a positive development for the economy overall. 

Whenever the far out months are much higher than the near month, the indicator shown in this week's chart goes to a high level.  Getting it above 30% is a sign that the near month contract price is far too low, and the market's viewpoint about the current economic condition is overly pessimistic.  Saying it more plainly, current lumber prices are too low, and are likely to rise.  That is a positive development for the economy, and is suggestive that the Fed's efforts to keep short term rates at zero are misplaced.  The economy is about to rebound, whether anyone thinks so or not. 

How much of a rebound we get, and for how long, is not something revealed in this current lumber contango.  All it says is that lumber prices are too cheap right now, and they are likely to rise.  And that is a positive development for the economy going forward.

Looking only at the near month lumber price, we see an apparent break below the rising bottoms line.  That would ordinarily be a bearish sign.  But with the contango already so large, that additional evidence suggests that the breakdown is not likely to be sustained, and is instead a "false" breakdown.  The upward pressure from the out months should pull the near month price higher.