You Need to Consider This Crisis-Proof Investment

The past month has brought with it a big test for one of my favorite long-term investment themes: the crisis-proof investment of timberland.

Timberland is a crisis-proof investment because the growth of the trees does not move in step with economic cycles. You don't have to harvest when demand is soft. Let them grow, and trees will become more valuable anyway. Bigger trees equal more dollars.

Timberland as a timely and crisis-friendly investment might seem odd, given its ties to the housing market. In fact, demand for timber as a building material is weak right now, at least in the U.S.

As the housing market reaches depths not seen in a long time, the end of the deflating housing bubble seems a ways off. Housing inventory in the U.S. at the end of June was 4.9 million homes, or about 12 months of supply – a glut we have not seen since 1981. New housing starts are near 17-year lows. And perhaps most surprisingly, even though housing prices have fallen quite a bit already, there is probably plenty of room to go, based on at least one good historical indicator: price to income.

The price of a single-family home to median income is 3.4 times, a historically high number – even after housing prices have come off their peaks. The long-term average is close to 2.9 times, which means housing prices need to fall 17% just to reach the trend line. This assumes too that incomes stay where they are. Given a recessionary environment, that may be a poor assumption.

Of course, markets usually don't stop at trend lines, anyway. They blow through them on the upside and downside. All this means bad things for housing yet. So despite weak housing markets and no sign of an imminent turnaround, timberland values have continued to climb. Why?

There are three reasons for this, all making timberland a good investment today. They are scarcity, global demand, and institutional interest. Let's take a look at each of them...

Growing scarcity of quality of timberlands. The mountain pine beetle infestation had a very real effect on supply. North America will lose about 20% of its spruce, pine, and fir lumber over the next five to eight years. In addition, much of Canada's boreal forests are not economical, thanks to high costs and Canadian taxes, unless lumber prices rise significantly. Many of these businesses have already shut down.

Also, the U.S. government continues to set aside timberland for conservation – about 1.4 million acres per year. Add up all three, and you have a good case for tight supply.

The other big issue outside of North America is the reduction in Russian logs. Traditionally, Russia has been the low-cost provider of timber, but log export taxes have taken much of its timber off the global market. So as Russian logs withdrew, prices skyrocketed in markets in which Russia was a key supplier. In the frosty Baltic states, for example, lumber prices recently hit 18-year highs. Softwood prices were 57% higher than a year ago.

Global demand should increase. China is a giant here. It is the world's largest importer of logs. Its appetite has increased 16-fold in the last 12 years alone! As the Chinese build more homes, they'll need plenty of lumber.

In addition to China, the demand for biofuels has an impact on timberland. The use of wood pellets and cellulosic ethanol for fuel, for example, provides a source of growing demand for wood products. Wood is environmentally friendly, which could become more important as we get into reducing carbon emissions.

Growing institutional interest in timberland. There is a big slug of money in institutional vaults – like pension funds – slated for investment in timberland. By some estimates, there is at least $10 billion in funds seeking timberland investments. All the usual appeal of timberland – steady inflation-beating returns – has caught the interest of these whales. This provides a floor of demand for timberland.

These three factors keep timberland prices strong, even as housing markets stay weak. There is one other interesting point... Lumber has not yet really joined in the commodity cycle. Its pricing lags that of many other commodities.

Lumber pricing lags even competing building materials. The gap among lumber prices and concrete and steel, for example, is as wide as it's been in 20 years. So timberland – an increasingly scarce resource – ought to participate sooner or later.

That's why I'm encouraging my readers to hold on to their timber investments. Readers of Capital & Crisis have made nice gains in Deltic Timber. Deltic shares – along with the huge timber REITs Rayonier and Plum Creek – have held up well during the stock market meltdown.

As long as the three factors I've outlined above are in play, these stocks should continue to hold up... and timber will still make a great crisis-proof investment.

Good investing,

Chris Mayer