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By Carl Delfeld

I just returned from a wonderful week in the Great Northwest. While driving through Olympic National Park just a few hours from Seattle, I had to ask my kids to please turn off the iPods and appreciate the majestic surroundings.

“Okay, Dad,” they groaned. “But it’s just more trees…”

Sure, they had a point. Thousands of towering trees – some more than 200 feet tall – closed in on us from all sides for hours on end.

Breaking the marvelous monotony were areas that had been recently cut and replanted. I couldn’t help but think that we have certainly come a long way from the cut and burn practices used by the timber barons of the nineteenth century. Forestry, in America anyway, is now a sophisticated, sustainable and scientific business.

Most importantly, timber has proven over the years to be a terrific investment…

The Price of Lumber Outperforms S&P 500

The price of lumber during the past century has gone up an average of five percent annually, outperforming the S&P 500 (SPY) Index with the added bonus of lower volatility. Since 1987, the Timberland Index is up nearly 15 percent per year against an annualized 9.6 percent return for the S&P 500.

One reason for this steady growth is that timber prices tend to follow population and economic growth. Emerging market nations like China and South Korea are key drivers of growing demand for lumber products. Another nice aspect of the timber business is that timber owners have the flexibility to slow harvesting rates when prices are weak and expand as prices rise.

Timber also holds up well in bear markets and tough economic conditions. When stocks plummeted during the Great Depression, timber gained 233 percent. And in 2008, when the S&P 500 lost 38 percent, the Timberland Index gained 9.5 percent.

Timber also seems to offer a better inflation hedge than gold.

  • Gold seems to me to be more of a hedge on political or economic instability than on higher inflation.
  • Timber, once again, follows population and economic growth, has practical uses in construction and paper products, and isn’t prone to volatile cycles.

"Do Forest Assets Hedge Inflation?" by Courtland Washburn and Clark Binkley (Forest Science, August 1993), determined that timberland assets offer an excellent hedge on “higher-than-anticipated inflation.” This is backed up by timberland values surging an average of 22 percent a year during 1973 to 1981 when inflation averaged nine percent.

Why Now is a Good Time to Get into Timber Assets

This also seems to be a good time to get into timber assets. China, South Korea and Japan are all eager buyers of lumber and exports from the West Coast are booming. Lumber prices were up 18 percent in 2010 and about 20 percent in the first quarter of 2011. No wonder institutional investors have poured over $30 billion into timberland investment management organizations (TIMOs), up from $1 billion in 1989.

So what are the options for individual investors considering taking some gains from any gold positions off the table and diversifying into the timber trade?

  • There are stocks. For example, Plum Creek Timber (NYSE: PCL) is the largest private landowner in the United States owning timberland in 19 states. I like that its assets are highly diversified geographically and by type of trees; from redwood and spruce to oak and ash. A kicker is that the company has some natural gas and mineral assets that it’s developing as a side business. Plus, the stock sports a nice 4.2-percent dividend yield.
  • For a broader global approach, there are ETFs, like Guggenheim Timber ETF (NYSE: CUT). CUT is a basket of companies in all aspects of the timber, lumber and paper business. U.S. stocks comprise just 30 percent of the companies in CUT. Japan makes up about 18 percent of the fund while large allocations also go to Canada (9.5 percent), Finland (9.2 percent) and Sweden (8.5 percent).

Timber is a great addition to any well-diversified portfolio and a proven hedge against higher inflation.

Disclosure: Investment U expressly forbids its writers from having a financial interest in any security they recommend to our subscribers. All employees and agents of Investment U (and affiliated companies) must wait 24 hours after an initial trade recommendation is published on online - or 72 hours after a direct mail publication is sent - before acting on that recommendation.

Source: Timber Investing: An Inflation Play a Cut Above Gold