Increase in Housing Starts Contributes to Lumber Run-Up, or is Nonexistent

As per my post last night, and today's news on housing starts, I certainly ought to eat a little crow; according to the Census Bureau, January housing starts were up from December, as well as January 2009. Specifically, according to the Bureau's report:

Privately-owned housing starts in January were at a seasonally adjusted annual rate of 591,000. This is 2.8 percent (±11.5%) above the revised December estimate of 575,000 and is 21.1 percent (±12.3%) above the January 2009 rate of 488,000.

So yes, it appears I was wrong with my initial assessment and the housing market indeed showed signs of picking up in January, potentially contributing to the Lumber run-up of the last month. However, the actual meaning of the housing start increase is slightly more complicated than the above quoted numbers and, I would make the case, much less meaningful than reports are making it out to be. Let me explain.

First, regarding the meaning of the number itself, the 2.8% increase in housing starts is an increase in the seasonally adjusted housing start rate. Because the US Housing market is highly seasonal (i.e. more building projects begin in the spring and summer months) examining trends on a purely month to month basis is not meaningful when analyzing long-term trends. Housing starts will almost always go up in March, and they will almost always go down in October. As such, the US Census Bureau developed a statistical method called X12 (and its predecessor X11) used to remove the expected seasonal effects of this type of data. The best article I could find describing the algorithm is, oddly enough, on an old Federal Reserve Bank of Dallas webpage, but suffice to say the algorithm is designed to remove expected seasonal effects for a given data series, thereby showing the actual overarching trend. Thus, the published number is a point estimate for what the current annual housing start rate is; in this case, 591,000 housing units started per year. As with any statistical analysis, there is a margin of error to that point estimate, and the margin is given right in the reporting sentence. "This is 2.8 percent (±11.5%) above the revised December estimates..." Wait a minute, 2.8% ±11.5%? That should give us a range of –8.7% to +14.3% and, if I'm not mistaken, –8.7 ≤ 0 ≤ 14.3. As any statistician can tell you, a confidence range that includes zero is not statistically significant at all. And the Census Bureau uses a 90% confidence interval in their calculations, so it's not as though they're being overly conservative with their estimates and confidence ranges. In other words, this number is fundamentally meaningless. In fact, if you actually bothered to read the report (as apparently no one in the media did) you'd see that the "±11.5%" figure is asterisked with a footnote that reads as follows:

"90% confidence interval includes zero. The Census Bureau does not have sufficient statistical evidence to conclude that the actual change is different from zero."

So, in other words, there is no evidence that there was a change in the seasonally adjusted rate WHATSOEVER. This number is meaningless.

Moving on, despite the lack of evidence for a month over month change, the increase in rate from January last to now does appear to be truly significant, with a confidence interval of 21.1 percent ±12.3% (between 8.8% and 33.4%) for the change from January 2009's seasonally adjusted rate. (Note that that range does not cross zero.)

The report also lists the raw housing start numbers (those that haven't been seasonally adjusted). Here are the highlights (all numbers pulled from the aforementioned report):

• 2008 Year in full: 905,500
• 2009 Year in full: 554,500
• January 2009: 31,900
• November 2009: 42,300
• December 2009: 37,100
• January 2010: 37,800

The takeaway from all of this is that the housing market has improved significantly since 2009. In fact, using either the December or January estimate for the seasonally adjusted housing start rate yields a significant improvement over the 2009 total figure. However, there is not sufficient evidence to suggest that any further progress has been made over the last two or three months, the numbers (both seasonally adjusted and raw) do not demonstrate sufficient statistical significance to draw that conclusion. Starker still, is that the market today remains at about 65% of where it was in 2008.

How did the Lumber market today respond to all this? Somehow, despite the hype, prices moved mostly sideways; either this information was already priced in, or it doesn't really exist.

Full Disclosure: As of writing, author is short May 2010 Lumber (LBK10)

WSJ commodities headlines continue to tell us when it's cold outside

As I discussed in a prior post, whatever the natural gas market is the other nine months of the year, during the winter it's an inverse thermometer for the Eastern seaboard. Take a look at these natural gas headlines for the last month from the Wall Street Journal:

• 1/6/2010 - Cold Weather Heats up Natural Gas, OJ Markets
• 1/15/2010 - Natural Gas, off 2.5%, Falls on Mild Forecast
• 1/23/2010 - Chilly Forecasts Lift Natural Gas
• 1/27/2010 - Natural Gas Falls on Milder Forecasts
• 2/1/2010 - Elements Hold Down Natural Gas*
• 2/2/2010 - Cold Weather Boosts Natural Gas

Couple things to notice here, the first is that the 1/23 headline was modified from its original incarnation "Cold Forecasts Warm Up Natural Gas Prices" sometime between when I wrote my prior post and now. In fact, you can still see that headline as the page's title. So it's good to see that someone over there is insisting on slightly more variety of diction, even if the changes are occurring four or five days late.

The second, and more important thing to notice, are the functionally opposite headlines occurring 24 hours apart on 2/1 and 2/2. Anyone at all (say, for example, a professional commodities analyst) could point to at least TWO prior headlines that month and say that the news of EITHER 2/1 or 2/2 supports her model of rising OR declining gas prices. The volatility of these markets, especially when the weather is your primary driver, makes every session a significant one.

*In the print version of the 2/1 article, there was also a B-Roll shot of some dudes playing football in Washington DC with the caption:

"ICING THE KICKER? Unusually warm weather was a boon for football players in Washington in November; not so for those betting on gas."

Awesome. That picture really helps me get a better understanding of the natural gas situation. You couldn't have put a chart there or something? (NB: Yes I appreciate the irony of making fun of a superfluous picture, and then not showing said picture myself while discussing it, but wsj.com seems not be hosting it. Apologies.)

Wall Street Journal Reporter Sets New Standard for Awful Journalism

Despite its attempts to predict the future, I'm generally a fan of the Wall Street Journal; I know of no other publication that so succinctly and clearly gives you the day's most important business news. People who read the WSJ thinking they're getting an edge on where the markets are headed couldn't be more self-deceiving, but if you're just looking for the basics of what happened in the markets, you'd be hard pressed, in my mind, to find a much better source. Also, for those scant of us who follow commodities, the WSJ is one of the few places I know among major media outlets that actually gives page space to the markets (albeit succinctly and usually on the back of section C).

Okay, now, with that caveat out of the way, I have to say that yesterday's article: "Traders Bet on an Oil Breakout," which purports to be the day's "Commodities Report" is unquestionably one of the most shallow, poorly researched, amateurish articles I have ever read. Anywhere. In my life.

Let's start with the headline:

"Traders Bet on an Oil Breakout"

Is that so? Which traders? What kind of break out are we talking about here? Up? Down? How big are these bets? Surely the article will expand...

Moving on, from the second and third paragraphs we get this:

"Since October, prices [of oil] have largely ranged from $70 to $80 a barrel, the narrowest four-month band since mid-2007. An oil "fear gauge"—the CBOE Crude Oil Volatility Index—early last week fell to the lowest level in more than two years.

But in the past few sessions, trading in the crude-oil options market has shown signs of reviving... While oil prices remain within that trading band, the volatility index has bounced off the bottom, according to some traders."

Note that this does not say that the crude oil market has picked up, rather the crude oil options market has shown signs of reviving, and we're given this graph of the volatility index to, I have to assume, support that statement. See if you can pinpoint the obvious bouncing off the bottom mentioned in the above paragraph:

See that big, significant bounce way down at the end there? Neither do I. It looks much more like random movements typical of every single market everywhere on the planet since the invention of markets. Which traders claimed the volatility index has jumped off the bottom? Oh right, some traders.

Back to the article, jumping ahead to the seventh paragraph, the author switches gears to talk about what's driving oil prices, and we get this doozy, possibly my favorite series of sentences that I've ever seen in a serious publication about financial markets:

"New swings, either up or down, likely will be triggered by expected changes in supply or demand. Some expect oil prices to tumble, taking a cue from last week's selloff in stocks, which fell on fears of another downturn in the global economy. Others say prices will soar because of stronger economic growth and fuel consumption."

Go ahead and read that again. Maybe think about having a calligrapher write it out and then frame it and put it on your wall. It would almost make a nice zen koan were it not so idiotic. Consider that this reporter, whose job is, apparently, to write news stories about financial markets, actually took the time to write that first sentence and pass it off as legitimate reporting. Did anyone read this article and suddenly have the epiphany that changes in supply or demand of a commodity might affect the price (either up or down, remember)? Next, we get two fantastic sentences telling us that some people think the price of oil will go up, while other people think the price will go down. Does this reporter have some insider on the NYMEX who's sending her tape recorded conversations from the back rooms, or has she made this inference all by herself? In other news from the world of logical tautologies:

• If P, therefore P.
• Q or (not Q).

The rest of the article goes on to talk about the proposed oil position limits by the CFTC (which I've previously discussed at length) and how they've caused some speculators to exit the market. This second half, so to speak, in its own right is actually a reasonable bit of reporting, but it certainly doesn't belong under this headline of "Traders [Betting] on an Oil Breakout". It's sort of like reading two different articles, one written by a reporter, and one written by that reporter's (admittedly precocious) 9 year old child.

What could have been improved? Other than "everything", this article is essentially three different articles, none of which is actually meaningful in its current incarnation. If this were an article discussing the signs pointing to a return to volatility in the oil market (as the headline purports) then a lot more work should have been done to determine if that "bounce" in the CBOE Volatility Index reported by some traders as the bottom is the result of explicit returns to the market by speculators and/or hedgers, or if it's just random noise. There is a mention in the article that Southwest Airlines, Newfield Exploration Co, and Chesapeake Energy all "recently" increased their hedging positions. If the CBOE volatility index increase is the result of hedgers taking greater positions, that implies less volatility than if these were speculators reentering the market. Do some reporting and figure out which it was.

If, on the other hand, the article were to focus on this crazy "supply and demand" theory that's been posited by the author, it should actually show some trends and figures for supply and demand. Is there a correlation between oil reserve estimations and volatility? How have global import/export numbers looked for 2009? What do the fundamentals suggest?

And lastly, if instead the article were to focus on the proposed CFTC regulations, maybe it could talk about how those regulations will affect volatility. The article ends with a quote from the global head of energy trading a Société Générale (a European corporate bank I've never heard of) talking about why hedging is important for companies that produce and consume oil. This is altogether worthless information. Of course hedging is important for companies that produce and consume oil. A better, more meaningful question to end the article would have been: "If enacted, how do you imagine the CFTC imposed position limits on speculators will affect volatility and/or liquidity? What does your bank plan to do if these limits are enacted?" At least then we would have seen an opinion that may provide insight into the the current state of the market.

Seriously Wall Street Journal, proofreading means more than checking for spelling or grammatical mistakes.