Lumber in August

07/27/04 11:55:54 AM

by David Penn

Will recent highs in lumber futures mark the top of the bull market?

Security: LBX4
Position: N/A

Back in late June, I wrote an article for Traders.com Advantage suggesting that lower prices might be ahead for lumber futures ("Is Lumber Headed Lower?" Traders.com Advantage, June 22, 2004). The crux of the argument at the time rested upon a head and shoulders top that appeared to be developing in July lumber futures over the course of April, May and June.

At the time I pointed out that while prices appeared to have broken beneath the neckline, "should July lumber slip back and take out the low that was formed during the initial break to 376, then more downside should follow swiftly afterward." As it turned out, July lumber did not take out the 376 level, at least not on a closing basis. While there was an intraday low of about 373 or so, the lowest close in the post-breakdown period was 376.50 -- close, but no cigar.

This, by the way, was a good thing, because by the time July lumber futures made it to July, they were ready to rally. In July, lumber futures moved up at a tremendous pace, climbing from a end of June price of about $380 to a near-the-end of July price of more than $440.

But there are some signs that the top that apparently wasn't ready for lumber back in May might be more than prepared to show itself in July and August. These signs are two-fold: a deep MACDH trough in late May and into June and a growing negative divergence between the 7, 10 stochastic and price (basis November futures).

Will an almost vertical rally in lumber futures in July result in a similarly vertical collapse in August?

Graphic provided by: Prophet Financial Systems, Inc..

It must be re-iterated that rallying markets tend to keep on rallying, and lumber futures in late July (basis November) have exceeded their May highs by about 20 points before pulling back somewhat. Nevertheless, November lumber is quite extended above its 20- and 50-day exponential moving averages (both averages are below the May highs). This latter point is short-term bearish and augurs a correction of some scale if and before lumber futures are to resume their bear market.

Lastly, while I cannot detect any cyclical behavior in lumber futures (not to say that such behavior doesn't exist, but simply that I haven't been able to discover it), a chart going back to January 1992 suggests that there may be some long-term cyclicality to this commodity, with price spikes coming roughly every 2 to 3 years since 1993 and somewhat more sporadically in the years before then (with lumber peaks in 1987, 1983, 1979, 1973, 1969 and 1966). Looking at the pattern over the past ten-odd years, it clearly looks that lumber is either nearing a historic top or is about to break the historic mold, as prices hurtle back towards the $450 level.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Lumber in August

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