The Expert Podcast

Here's an interesting development from the financial industry about trading lumber. This is one of the first major developments in lumber finance that's happened in decades—maybe even a century. It used to be that lumber prices and lumber futures were sold in rail car volumes. Now, they're breaking it down into truckload volumes. There's a new contract that you can trade that will sell two-by-four lumber batches in smaller loads with a central delivery point.

What does that mean? It means that there's a new lumber futures product, and it's trying to eliminate some of the price swings of the larger thousand-board-feet security. The ticker symbol for this will be LBR, and it will represent a truckload of boards instead of a rail car. The delivery point is Chicago rather than a remote Canadian rail junction. The specification will allow for Eastern Spruce, Pine, and Fir instead of only Western Fir like Douglas Fir.

This is going to be an interesting development where traders and lumber yards can get a more specific read on lumber prices. Because it's a smaller batch—about a quarter of the volume of wood for a truckload instead of a rail car—and it's FOB (Free on Board) Chicago rather than out of the country, there won't be customs delays. The futures contract will start next month, and the current contract expiring in May will be the last listed under the existing specs. They're planning to phase out the Canadian rail car in about a year.

The change is aimed at drawing home builders, lumber yards, and sawmills into a market with limited participation. This way, it's more reliable because you don't have to worry about customs, limited wood species, or dealing with large volumes. Under the old contract, swings could range from $176,000 to $20,000 per day—up or down. This new system is a completely different way to peg the lumber market, and it will significantly impact how lumber yards buy and sell goods.

It will do that because the lower price will attract more speculators and add liquidity to the market. Instead of just big players handling $200,000 contracts, smaller companies—like home builders and small lumber yards—can participate with $40,000 to $50,000 contracts. This way, they can buy these futures and trade them to hedge their bets.

For example, if you're building a house, by the time you get your permits and contracts with the homeowner, lay the footings and foundations, and then start buying your lumber package, you can peg or hedge your bets for lumber futures. This will help prevent too much volatility and uncertainty in your costs. You may not have to buy the full contract, but purchasing an option on it will at least ensure you know the maximum price you might have to pay. It will help smooth out cost fluctuations for builders and lumber yards.

Currently, the lumber package requires building six houses to make a contract worthwhile. Many builders only build one or two at a time. With the new LBR security, you can build one house at a time—or maybe two, depending on the size—and hedge your future expenses for at least part of your lumber package. While labor costs will still be volatile, at least your lumber package will be established, and you'll know the upside and stop-loss for your materials.

Let us know what you think about this new pricing and how it works!