The Wall Street Journal recently reported that the DJIA and S&P 500 have advanced ~30% and 35% respectively off their March 9 lows. The markets are also buoyed by the strong May performance of the Conference Board Consumer Confidence Index, which came in at 54.9 — this is the highest reported figure since September 2008 and a 14.1 increase from April. The recent performance of these indexes demonstrates that formerly weary investors are clearly responding bullishly to the government’s economic policy of active intervention in the banking system and select industries. Although positive sentiment is materializing, my good friend, market maven, Clear angel investor and uber blogger Roger Ehrenberg plays devil’s on his blog regarding continued economic troubles:
“As the US Treasury continues to run the printing presses, the Chinese would gradually build a compelling argument (and a powerful economic position) as to why the US Dollar should no longer be the global reserve currency and the basis of exchange in oil. Profligate spending coupled with fewer willing buyers will drive up US dollar long rates, debase the currency and set off a very unpleasant inflationary cycle.”
Portfolio diversification comes immediately to mind as investors get a little too comfortable with risk again. Materials ranging from cooper to oil have been rallying along with the market. Timber is a vaunted hedge against the potential inflation we could be facing that is also championed for its uncorrelated and less volatile returns when compared to both international and domestic equities. Another fellow blogger on AllAboutAlpha states the key figures to know:
“According to USDA stats cited by Weyerhaeuser, trees grow 4% per annum on average.”
The remarkably smooth, largely positive return on Timber is due to that 4% whether boom or bust, the forests of the world can still be counted on to grow by roughly that amount. The underlying engine behind this return is that when a tree grows, there is more wood to be harvested and thus it has become more valuable. Generally speaking, a larger tree has more mature and more value wood as well. A J.P. Morgan Analytics whitepaper on the asset class states that this 4% annual growth is responsible for “approximately 65%-75% of the timberland return.”
Put simply: between 2/3 and ¾ of the annual return of timberland is consistent. This margin of safety is very appealing.
The JP Morgan whitepaper reports that about 25% of the return generated on timberland is based on its current market price. This figure is minute compared to the impact tree growth has on the asset class due to the amount of control landowners can exert. When the price of wood is down due to poor economic conditions, timberland owners can sit on their land and timber assets, leasing them for recreation and allowing the land and trees to appreciate via growth courtesy of sun and rain. The asset class is relatively immune to the general state of the economy. Timberland is still “sowing” profits even when its trees aren’t harvested.
The society of American foresters also states that the average American consumes a 100 ft. tree in wood and paper products. That is in the US. Demand is lower and should increase along with consumption in emerging markets; however the supply of timberland itself is a finite commodity. China alone is building cities dwarfing the US and Western Europe and urbanizing populations that will bring per capita use of wood products closer to Western numbers further increasing demand.
Big players like the Harvard and Yale endowments garnered publicity and low-volatility profits by purchasing timber land, and a recent chart of the asset allocations of European pension funds show that timber land ownership is becoming a more accepted form of alternative asset.
Those who have been reading my blog know, we created the Beacon Global Timber Index which is tracked by the soon to be renamed (from Clear to Beacon) Clear/Claymore Global Timber ETF on the basis that companies who own, manage and harvest timberland should outperform comparables that do not tap into this steady stream of revenue over time. Constituent proportion is determined based on the amount of acres of timberland owned compared to timberland of that region.
The index has underperformed the market thus far, but I am still bullish on the underlying thesis. Furthermore, the average holding of the ETF is trading at less than half book value and a .26 of sales. As so many market participants and the media are pointing out, while there is a current wave of investor optimism, one must also prepare for less positive scenarios in portfolio construction. The J.P. Morgan paper states that $100 invested in Timberland in 1987 would be worth $2,190 as of December 2008 — this return is made even more attractive by a sharpe ratio that is more than double the S&P 500; it’s worth a look for your portfolio.
Shout out: This post was researched and initially drafted by intern Jimmy Baker.
Disclosure: Mr. Corn is Chief Investment Officer – Equities of Beacon Trust Company. Beacon Indexes (formally Clear Indexes) designed and publishes the index tracked by Claymore/Clear Global Timber Index ETF (NYSE: CUT).