Has Lumber Bottomed?

02/03/03 10:17:33 AM

by David Penn

Bump-and-run reversal or set up for a head and shoulders bottom ... the lumber bear market appears to be ending.

Security: @LB
Position: N/A

If you think you had a bad 2002, then consider a commodity like lumber. While Americans jumped for joy over the prospect of easier credit terms for buying and refinancing home purchases, one of the main ingredients in such homes--lumber--saw its price decline and decline and decline. Starting off 2002 in the neighborhood of 316, lumber prices (as measured by continuous futures) climbed to a high of nearly 367 by March--a gain of 16%.

Unfortunately, it was as if someone shouted "Timber!" shortly afterwards. From a high of 367, lumber futures tumbled for the rest of the year. While there were intermittent rallies--almost one a month from the March peak to the lows reached in December--those rallies were more like the jostling of a body falling down a flight of stairs than any real opportunity for lumber's slide to stop--or even pause momentarily. By the time 2002 ended, lumber futures had fallen to about 224--a drop of almost 39% in one year.

Lumber looks like it is forming some sort of base between the lows of September 2002 and the lows of January 2003.

Graphic provided by: TradeStation.

But there are signs that lumber prices may have bottomed--at least in the intermediate term. While the December 2002 lows were measurably lower than the two previous attempts to establish a bottom in September and again in November, the December lows were close enough to consider the month part of what appears to be an attempt to establish a base--arguably of the complex head and shoulders variety. For a complex head and shoulders bottom to form, lumber prices would have to retreat from their current rally--a rally that has seen lumber prices in January rocket up from about 230 to nearly 265--yet hold above the lows of November and September (a zone between 235 and 232).

It is also worth noting more simply that the January 2003 rally in lumber also occasioned a break of the downtrend line that extends from March 2002. In fact, the initial trendline break on January 9th and 10th and the failure to establish a new low with the decline on January 22nd all support the possibility of lumber experiencing a 1-2-3 trend reversal--a reversal strategy for picking tops and bottoms in trending markets that I have discussed frequently in previous Traders.com articles (see "1-2-3 Reversals and Commodities," Traders.com Advantage, November 26, 2002, for one example).

Another possibility is that lumber has begun what Tom Bulkowski refers to as a bump-and-run reversal bottom (see his Encyclopedia of Chart Patterns or his forthcoming article in Stocks and Commodities magazine, "Uncommon Chart Patterns"). At its most basic, a bump-and-run reversal bottom occurs when prices hold relatively close to a downtrend line, then suddenly and dramatically fall away from that line, plunging much faster than the downtrend line suggests they would. Prices eventually make a bottom and then soar back up to and through the downtrend line. Bulkowski suggests that bump-and-run reversal bottoms have the appearance of a frying pan with the handle on the left. Here, prices do not hold as tightly to the downtrend line at the beginning of the downtrend as I might prefer, and the "fall away" from the downtrend line in the summer of 2002 could be more pronounced and dramatic. Nevertheless, the scope of lumber's previous bear market and the possibility of one of the two bottom reversal patterns succeeding (either the complex head and shoulders or the bump-and-run reversal bottom) is such that those on the short side of lumber who've profited handsomely in 2002 may want to consider taking something off the table--before the lumber bulls tip the table over entirely.

David Penn

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

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Date:�02/04/03Rank:�4Comment:�Been long on lumber because of this.

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Has Lumber Bottomed?

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