Don’t be stumped by timber

It’s a good choice for patient investors

The poet Wallace Stevens published “Thirteen Ways of Looking at Blackbird” in 1917, launching thousands of befuddled English papers and hundreds of parodies, including “Thirteen Ways of Eradicating Blackbirds,” by Mark DeFoe. Here’s number three:

III. Drop brochures of Capistrano, complete

With winter rates. Tell them they are swallows.

But as winter retreats and

spring takes hold, it’s a good time to look at trees. And while there aren’t 13 investment themes to take from trees, there are three — and they’re good ones.

I. Lumber prices are a good predictor of stock market volatility.

This may sound farfetched, but it’s the subject of an award-winning paper titled “Lumber: Worth Its Weight in Gold — Offense and Defense in Active Portfolio Management,” by Michael Gayed and Charlie Bilello of Pension Partners. In a nutshell: When lumber outperforms gold over the previous 13 weeks, you should be more aggressive in the stock market, and when gold outperforms, you should be more defensive.

Why lumber? Lumber prices are a good indicator of the housing market — which, in turn, is a good indicator of the economy as a whole. And unlike most housing indicators, lumber isn’t lagged by weeks or months, as are things like housing starts and home prices. Nearby lumber futures prices are available throughout the trading day.

While home construction is a relatively small part of overall economic growth, it has an enormous ripple effect. When you buy a new home, you not only employ dozens of workers and purchase lots of raw materials, you also make work for the folks at Home Depot and Nuts 2 U Nursery.

Gold, on the other hand, is a good measure of fear. People buy gold when they think bad things will happen. “In multiple cycles, when lumber outperforms gold, the stock market tends to be less volatile,” Bilello says. “The economy is improving and in an expansionary phase. And it’s the opposite when lumber is underperforming.”

What is timber telling us now? “From the end of last year, lum-

ber has been underperforming gold,” Bilello says. “It doesn’t mean that stocks have to go down — it simply means that there is a higher probability of volatility rising.”

How defensive you want to play the lumber indicator is up to you. You could move to intermediate-term bonds if you’re really leery of the market. Or you could move to more defensive sectors, such as health care or utilities. Or you could invest in low-volatility stocks, such as those in the S&P 500 Low Volatility Portfolio (ticker: SPLV).

Conversely, when lumber clubs gold, consider being more aggressive, either by increasing your stock holdings, or increasing your holding of more volatile smallcompany stocks.

One word of warning: Wall Street currently looks at bad economic news as good, because that means the Federal Reserve will keep rates low longer. “It’s one of the few periods in history where weak economic news is being well received on Wall Street,” Bilello says. And that might warp the lumber indicator a bit.

II. Invest in timber for the long term.

GMO LLC, a respected Boston money manager, periodically issues a forecast for various types of investments over the next seven years, adjusted for inflation. Their most recent outlook is fairly gloomy: U.S. large-company stocks will lose 2% a year, and high-quality stocks will gain just 0.5% a year.

The standout: timber, which GMO forecasts will gain 4.8% a year, after inflation.

“The fundamental case is that the returns from timber for patient investors should be steady,” says Eva Greger, head of GMO’s renewable resources group. It doesn’t mean that timber will be, well, growing rapidly. “The thing about timber is that it doesn’t move around a lot,” she says. Timber looks better than stocks not because timber is soaring, but because stocks are expensive. Managed timber has its charms: If the market for timber falls, a manager can simply let the trees stand and grow another year, which makes them more valuable. Over the very long term, demand for timber tends to grow, especially as supply diminishes as forest land gets converted to use in agriculture or real estate development. (Or, more happily, enshrined in national parks.)

GMO wouldn’t recommend timber-related investments, or any investments for that matter. They don’t do that.

You might, however, look at the handful of real estate investment trusts that are devoted to timber. Plum Creek Timber (PCL), for example, is the largest timber REIT, which owns 6 million acres of timberlands in 19 states. But the stock isn’t cheap, despite its current 4.1% dividend yield, and land sales drove 43% of earnings before interest, taxes, depreciation and amortization, according to Morningstar.

A less expensive choice is Rayonier (RYC), which has 2.6 million acres of timberland. One reason it’s cheap: The company sells significant amounts of timber for paper, which will decline in this digital age. And it has overharvested in the Northwest, according to Morningstar. But it should benefit as timber demand increases, especially in the South.

III. You need a lot of patience — and land — to make money growing timber on your own.

High-quality hardwood, such as walnuts, can fetch high prices. Why not skip making an IRA contribution this year and plant a couple of walnut trees instead?

And that’s an interesting thought. Greger points out, however, that timber is no sure thing. You’ll have to be on guard against fire, insects and the occasional beaver. And you’ll need time. So you can learn a great deal from lumber, and, with the right investments, actually make some money. But the best return you can get is to walk outside on a spring morning and see them in bloom.