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Lumber futures have caught a spark since we last wrote about forest products (Canfor: A Constructive Timber Stock).

CME March 2011 Random Lengths lumber futures reached $$289.50/tbft Wednesday, up $35 over the last six trading sessions. (Post Script: it backed off in after-hours Globex trading. This is a price level not seen since mid-May.)

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It could be the spreading moratorium on house foreclosures in the U.S. has boosted expectations of better new home building. More likely, it could be the thought that West Coast Canadian lumber will be in short supply in the future due to the Mountain Pine Beetle devastation. And there is the threat that the U.S. will impose sanctions due to trade complaints from the Coalition For Fair Lumber Imports. Both these factors could reduce future total North American supply of SPF 2x4’s and other popular varieties.

Finally, as we would argue, it’s probably a sign hedge funds are sweeping into any tradeable commodity now that the U.S. Fed's easing has put a “Buy Me” sign on all USD-denominated hard assets.

A downside to Canadian sawmill profits is recent Canadian dollar strength, but we feel this is offset by the West Coast companies having increasing success selling product into China, Japan and Korea. With Canadian interest rate hikes most likely on hold and seasonal year-end weakness approaching, the Canadian dollar might stop rising so quickly, and improve domestic prospects.

We don’t want to be in a position of loading up on Canadian forest stocks because we see lumber futures rallying – and be the last trader to find out it’s the dampening prospects of our own holdings that are causing the rally! But we think fears about the MPB and trade action are overblown.

In Canada, we like Canfor (OTCPK:CFPZF) (At $8.21, up 20 cents on 300,000 volume), Interfor “A” ($4.15 up 5 cents on a whopping 2 million share shares including institutional blocks) and West Fraser Timber ($37-$38). Eastern Canada forest products company Tembec (OTCPK:TMBCF) (at $2.05, up 2 cents on 554,000 volume) is appropriate for more speculative traders with a small float and high U.S. debt that was recently refinanced with an onerous 11.25% coupon.

Results for Q3 begin with Interfor (October 22) followed by West Fraser Timber (OTCPK:WFTBF) (October 26) and Canfor (October 29).

A reliable B.C. industry source tells us any trade action from the U.S., if successful, would take at least a year or two to work through the arbitration process. And, if successful, it would probably result in much less than the $300-$500 million in damages claimed, levied as an extra penalty on top of the current 15% export tax.

Any higher lumber price would make this just another cost of doing business, and there is always the possible chance prices rise over the tax threshold as they did, so briefly, back in the spring.

Lumber equities have slowly begun rallying on the upsurge in lumber futures, especially in the U.S. names, because the beneficiaries of the MPB and/or any trade action are thought to be American.

The largest U.S. timber REIT, Plum Creek (NYSE:PCL) is trading at $37.37, up $1.17 on 1.3 million volume. PCL was subject of a plug on CNBC’s Fast Money Tuesday night and has a big short position (10.8%) so it can be volatile. Smaller timber player Potlach Corp (NASDAQ:PCH) is at $36.12, up 92 cents on 141,000 and pays a higher yield but this is in excess of the company's cash flow so far this year. Plum Creek releases Q3 on October 25 and Potlach on October 28.

Recently trustified Weyerhauser (NYSE:WY) is trading at $16.10 up 26 cents on 3.2 million. Other timber REIT’s include Deltic (NYSE:DEL) and Rayonier (NYSE:RYN).

Given that several U.S. housing market indicators will be released next week beginning with the NAHB Confidence Index on Monday, there might be a buying opportunity at that time, on weakness, for this commodity value play.

Disclosure: Long Canfor, Interfor, Plum Creek and Potlach Corp

Source: Futures Suggest a Lumber Rally Ahead