Sell Some Gold, Buy Some Timber

| About: Guggenheim MSCI (CUT)
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No question that gold has had a nice run. It has been up 12 consecutive years and during this period gold prices are up around 500%. This is probably why in 2012, 84% of new cash invested in commodities went into gold funds. But these investors would have done far better if they had invested in another commodity that we use every day and that beat gold by 567% in 2012. While gold was up 6.6% last year - timber was up 37.4% and timber future prices were up 49%.

I’m not surprised. I grew up around a lot of trees and vividly remember our annual family camping trips in the north woods of Wisconsin. It seemed that millions of towering trees – some more than 200 feet tall – closed in on us from all sides for hours on end. But the best part of these trips by a long shot was the pancake breakfast specials and all the stories about the lumberjacks and timber barons.

Fortunately, the cut and burn practices used by the lumberjacks and timber barons of the nineteenth century have been replaced by a sophisticated, sustainable and scientific business model. And this is why timber has proven over the years to be a terrific investment. And looking ahead, no less than Jeremy Grantham’s GMO research team ranks timber as the #1 asset class for expected returns over the next seven years.

Let’s look at the long-term record of timber and why it is surging right now.

The Price of Lumber Outperforms S&P 500

The price of lumber during the past century has gone up an average of 5% annually, outperforming the S&P 500 Index with the added bonus of lower volatility.

Since 1987, the Timberland Index is up nearly 15% per year against an annualized 9.6% return for the S&P 500. Timber also holds up well in bear markets and tough economic conditions. When stocks plummeted during the Great Depression, timber gained 233%. And in 2008, when the S&P 500 lost 38%, the Timberland Index gained 9.5%.

What’s driving timber and lumber prices right now?

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.

The improved housing outlook and sharp pick up in construction is also wind at the back of the timber industry. Supply has been hampered by regulatory burdens. Timber harvesting on public lands in California is down 90% on public lands and 46% of its sawmills have closed since 2000.

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. And since timber, once again, follows population and economic growth, plus has practical uses in construction and paper products, it isn’t prone to volatile cycles.

Academic research finds that timberland assets offer an excellent hedge on “higher-than-anticipated inflation.” This is backed up by timberland values surging an average of 22% a year during 1973 to 1981 when inflation averaged 9%. No wonder institutional investors have poured over $30 billion into timberland investment management organizations (TIMOs), up from $1 billion in 1989. 

Here’s two ideas for you:

Plum Creek Timber (NYSE:PCL) - the largest private landowner in the United States. With some 6.6 million acres spread across 19 states, the company offers investors a mixed bag of timber assets. 

A broader play is Guggenheim Timber ETF (NYSEARCA:CUT). While not a pure play on timber - it invests in all aspects of the timber, lumber and paper businesses - the ETF gives investors a stake in the global wood business. 

American-based companies represent just 30% of the fund, which makes room for Canadian, Japanese, Finnish and even Swedish companies.

So my advice is to sell some gold and add some timber to your global portfolio for 2013.