Considering Timber as an Asset Class

Includes: CUT, PCH, PCL, RYN, WOOD, WY
by: Asif Suria

Investment objectives are as varied as investors themselves with some looking for short-term gains, while others are looking for long-term growth and yet another segment seeking a steady stream of income from their investments. Wouldn't it be great to have an investment that not only increased in value but also grew physically as you held it? Imagine purchasing a troy ounce of gold on January 3, 2008 for $288.50 and watching its value increase 183% to the recent $816.3 per ounce. Now imagine how thrilling it would be to have that one ounce of gold become two ounces while you were holding it.

Timber is one such investment that can not only increase in value but can also physically grow as you are holding it. The kicker is that you also get a green investment as many timber companies harvest planted trees as opposed to harvesting old-growth trees, hence preserving timberland.

We discussed the importance of asset allocation in the October investment newsletter and I figured it would be a good idea to expand upon that theme and discuss timber as an asset class in this newsletter. Here are some of the reasons to consider timber as an asset class for your portfolio,

  1. Timber has had an outstanding record as an asset class returning 14.5% a year between 1972 and 2006, outperforming all other major asset classes like stocks and bonds.
  2. Real prices of timber have always risen over a 100 year period outperforming nearly all other commodities as supply is limited (unlike oil, there are no new discoveries of timber), while demand is robust for construction and in use for paper products.
  3. Timber prices are usually less volatile than stocks and timber as an asset class is not correlated with stocks.
  4. North American forests grow at 8% a year and as tress get larger their value increases as well. Hence timber not only grows as an asset class, the growth is value added.
  5. If prices fall, timber companies can defer harvesting until a later date.

Here are some reasons why timber may not be the right asset class at this time or for some investors:

  1. Investors in timber usually are patient and have a very long investment horizon ranging from a number of years to a few decades.
  2. Timber has been falling rapidly since early 2006 due to lower construction demand and hence the low volatility claim appears to be in jeopardy for now.
  3. The construction industry appears to be in a long-term slump with October housing starts down 4.5% below September and a whopping 38% below October 2007. Confidence amongst U.S. homebuilders is currently at the lowest level it has ever been since the index of builder confidence was created in 1985.
  4. Given current market conditions there are several competing and undervalued investments that offer as good if not better yields than timber REITs.

Lumber consumption in the U.S fell 14% in 2007 and is expected to fall an additional 15% or more in 2008 based on consumption in the first six months of the year. One could argue that lumber prices already reflect soft demand with near month CME lumber futures having dropped from $300 at the start of this year to $193.50 currently, representing a drop of over 35%. The current price is also below a 12 year trading range of $200 to $450. For long-term patient investors it may be a good idea to scout out opportunities in this sector in case housing starts improve or home builder confidence turns positive (probably a lagging indicator). One could also dollar cost average into a position over a period of time to smooth out short-term volatility.

Individual stocks in this sector worth considering are Plum Creek Timber (NYSE:PCL), which is often considered the blue chip stock of the timber industry, Rayonier (NYSE:RYN), Potlatch (NASDAQ:PCH) and Weyerhaeuser (NYSE:WY). Plum Creek Timber is structured as a REIT and is more of a pure play than either Weyerhaeuser or Rayonier. Weyerhaeuser sold off its paper business and there is investor pressure on the company to convert to a REIT in 2009.

The Claymore/Clear Global Timber Index ETF, with the symbol CUT (sure to be disconcerting to environmentalists), contains both Rayonier (RYN) and Weyerhaeuser (WY) in its portfolio holdings and provides a diversified global opportunity to invest in timber. Another option is the iShares S&P Global Timber & Forestry Index Fund WOOD, which, in addition to Rayonier and Weyerhaeuser, also holds Plum Creek Timber and has a slightly lower expense ratio of 0.48% when compared to 0.65% for CUT.

However, the downside to these two ETFs is that they have significant exposure to paper, wood manufacturing and distribution companies instead of just timber REITs. This might explain why their returns are not exactly correlated to lumber returns. As discussed above CME random length lumber futures have dropped 35% so far this year while CUT is down almost 55% and WOOD, which started trading on June 25, 2008 is down more than 40% in just the last three months.

Instead of adding these timber REITs to the portfolio at this time, I am going to add Plum Creek Timber (PCL) and Rayonier (RYN) to our watch list in case there are sudden drops in their prices or housing starts show improvement.

Check out the following links for additional research and reading about timber and related topics.

Acknowledgement: Matt of Steadfast Finances assisted me with research for the "Timber as an Asset Class" section of this newsletter.