No Tumble in Sight for Timber

by Aaron Levitt | January 2, 2013 9:00 am

No Tumble in Sight for Timber

Ask investors what they think was best-returning commodity in 2012 was, and odds are you’ll get answers like gold, oil or even sexier natural resources like rare earth metals. Well, they’d be wrong. The answer lies in a hard asset on the more boring side.

Driven by several forces — including a rebound in the U.S. housing market, expanding pulp sales and a few issues with Mother Nature — timber became the commodity du jour[1] during the last year. Lumber prices surged throughout 2012 to reach a six-year high[2]. But investors need not fret that they missed out on the asset class’s gain in 2012.

With analysts predicting a new “super-cycle” brewing for forest products in the years ahead, there’s plenty of time to cash in on timber’s long-term appeal.

Double Digit Gains

Even with all uncertainty thrown up by the fiscal cliff, which was narrowly averted by the last-second deal on New Year’s Day, the U.S. housing industry is on track to show a gain in housing prices this year[3], albeit a modest one. That’s the first time since 2006 that housing has shown any sort of life. More important, the number of new homes has surged throughout 2012. New home construction is up more than 42% in the last year.

That pretty significant jump in housing starts is a primary reason lumber prices have followed suit.

Lumber has rallied to its highest level in more than six years, with the price of framing lumber — the kind used in new homes — hitting $373 per 1,000 board-feet. Overall, framing lumber prices jumped by 38% in 2012. Chicago Mercantile Exchange lumber futures rallied 43% during the year.

Those gains have pushed lumber to the top of the 24 commodities tracked by the Standard & Poor’s GSCI Spot Index. Yet, there are plenty of reasons to be bullish in 2013 and beyond.

Dwindling Supplies

According to International Wood Markets Group, lumber output in key producer Russia[4] has plunged since 2009 as various export quotas, fees and regulations have hindered its timber market. Supplies continue to be constrained elsewhere as well, including North America. Deforestation from pests like the mountain pine beetle and Asian longhorn beetle, as well as using more land for farming, has reduced available acreage. Despite being a renewable resource, wood is actually becoming scarcer.

At the same time, the recent recession has cut distribution chains in half across the U.S., and harvesting cutbacks in Quebec and British Columbia have kept supplies very tight — all in the face of rising global demand.

Of course, China has continuously boosted its lumber imports and now accounts for roughly 30% of British Columbia’s production. Analysts predict China will need to import about 182 million cubic meters of wood by 2015, a 70% leap from its current level. Japan’s timber imports are rising as well as it continues to rebuild after the 2010 earthquake and tsunami.

Then there’s the resurgent U.S. housing market[5].

Any continued rebound in housing will be a bullish sign for timber, especially considering rising Chinese demand wasn’t part of the equation the last time the U.S. housing market was rising. Housing starts in October reached an annual rate of 894,000. While far below the bubble-period peaks, that’s the highest since July 2008. Analysts see that figure exceeding 1 million by the end of 2013.

Planting a Forest

Considering timber’s long-term history of outperformance — generating an average annual return of 14% from 1987 to 2009 — investors should consider the sector in the new year.

In October here at InvestorPlace, I looked at various timber REITs[6] like Plum Creek (NYSE:PCL[7]) and Rayonier (NYSE:RYN[8]) as a way to play rising lumber and timberland values. However, there’s more than one way to chop down a tree.

A good — and often ignored — starting place could be Deltic Timber (NYSE:DEL[9]). The firm owns roughly 446,000 acres of timberland across Arkansas and Louisiana as well as two sawmills. That makes it a perfect play on the return of the U.S. housing sector and higher prices for framing lumber. More important, those acres are far away from the mountain pine beetles plaguing British Columbia’s forests — an added bonus for investors.

Deltic’s latest earnings report showed a 28% increase in average lumber prices for the quarter. That helped lift the firm to an overall rise in third-quarter profits[10]. Also helping were royalty interests in a number of natural gas wells on its property. The number of producing natural gas wells on Deltic’s land has gone up in recent quarters, and with natural gas prices finally rising[11], Deltic should have a nice stream of extra cash flooding its bank accounts.

That should help Deltic boost its token 0.40% dividend for patient investors. After all, patience is what timber investing is all about.

As of this writing, Aaron Levitt didn’t own any securities mentioned here.

Endnotes:
  1. commodity du jour: http://investorplace.com/2012/10/lumber-liquidators-mops-up-ll-hd-bldr-shld/
  2. reach a six-year high: http://www.bloomberg.com/news/2012-12-17/lumber-reaches-6-year-high-as-housing-rebound-erodes-u-s-supply.html
  3. a gain in housing prices this year: http://investorplace.com/2012/12/sp-case-shiller-index-home-prices-rose-in-october/
  4. Russia: http://investorplace.com/hot-topics/russia/
  5. housing market: http://investorplace.com/ipo-playbook/another-homebuilder-files-for-an-ipo/
  6. various timber REITs: http://investorplace.com/2012/10/prop-up-your-portfolio-with-timber/
  7. PCL: http://studio-5.financialcontent.com/investplace/quote?Symbol=PCL
  8. RYN: http://studio-5.financialcontent.com/investplace/quote?Symbol=RYN
  9. DEL: http://studio-5.financialcontent.com/investplace/quote?Symbol=DEL
  10. third-quarter profits: http://www.deltic.com/ir/3qtr2012earn.pdf
  11. prices finally rising: http://investorplace.com/2012/12/doe-report-should-push-natural-gas-forward/

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