The 30-Year Timber Investment Race
There’s a new investing generation. A generation weaned on the bottle of instant gratification. The stock market, for its part, has become the speculator’s lottery ticket. The evolution of complex financial instruments, cheap credit and a material-obsessed society formed this trend. Christopher Hancock explores…
Recently, my father-in-law hired a timber consultant to appraise the value of a large tract of timber he’s planning to harvest along the Mattaponi River in central Virginia. Before we went to meet this fellow, my father-in-law told me, "This guy’s been in the business for years – he knows his stuff." But I wondered…
On a damp Saturday morning, as we walked through a stretch of towering beech trees, I asked the timber man which species he’d recommend we plant following the projected harvest. He didn’t hesitate for a second. "Loblolly pines."
Now, I have no particular prejudice against pine trees. They just happen to be soft and cheap. They lack any real material quality other than providing an inexpensive source for framing brick-faced Dutch Colonials or serving as the Christmas centerpiece for millions come December.
So I asked: "Would you consider planting black walnuts?" I didn’t know the exact price difference, but I know black walnuts are worth considerably more than any species of soft Virginia pine.
"Black walnuts? You wouldn’t want to do that," he said. I pressed him for a good reason. He rubbed his beard for a second. "Black walnuts take twice as long to grow. You’ll have to wait more than 30 years before you ever see any cash from that type of tree. You can harvest loblollies in half that time."
I felt like the third-grader who truly believes his teacher when she assures her class that there’s never a "dumb question." Nine out of 10 quickly comprehend the meaning. There’s never a "dumb question" – as long as that question does not challenge the teacher’s all-knowing authority on any and all matters. One student, bless his heart, always takes the bait. At that moment, I was that student.
Since timber contracts usually entail a great deal of money, I kept digging – much to my father-in-law’s chagrin.
"How much would a mature loblolly pine sell for?" I asked.
"And what about a mature black walnut?"
"Well, you could probably sell a good walnut for $1,000," he presumed. "But you’ll never see that money," he chuckled. "Maybe your children will."
Is that fact so easy to dismiss? First, let’s be clear that timber investments are no different from stock, bond or even housing investments. In each case, you expect the asset in question to produce an adequate return over some designated period of time.
In this particular case, the question whether to plant pine or black walnut pivots around the individual’s particular investment time horizon. Loblolly pines mature roughly twice as fast as black walnuts. So someone who plants a pine receives twice as many cash flows as the man who plants walnut. But let’s consider the quality of those cash flows…
If a single walnut were worth exactly twice as much as a loblolly pine, the decision to opt for pine would be quite easy. But a single walnut generates approximately 10 times the cash flow of a single pine. Meaning over a 30-year period, a walnut harvest will generate five times the return as an investment in pine.
The 30-Year Timber Investment Race:
Pine: $100 per tree x 6 harvests = $600
Walnut: $1,000 per tree x 3 harvests = $3,000
For many, the decision to opt for walnut seems self-explanatory. Why then do most landowners opt to plant loblolly pines?
What happens when the majority of hardwood forests are being replaced with pine? The exponential supply growth of pine forests is bound to affect the price of a single tree 15 years down the road. And it won’t be to the upside, come harvest time.
Meanwhile, the dwindling supply of 30-40-year-old black walnuts will, assuredly, drive up the market price for the precious hardwood.
These are the long-term economic conditions my father-in-law must consider.
We tend to believe that the overwhelming, seemingly unquestioned conviction to plant pine demonstrates a growing trend among all investors today.
There’s a new investing generation. A generation weaned on the bottle of instant gratification. The stock market, for its part, has become the speculator’s lottery ticket. The evolution of complex financial instruments, cheap credit and a material-obsessed society formed this trend.
One of the more unique aspects of American culture, we believe, is class mobility. Americans tend to believe in their capacity to rise above the class to which they were born. In fact, this concept has been infused into our society from the very beginning. Our political icons constantly remind us of achieving the American Dream and becoming an "ownership society," as if to say that when you do better and achieve more, you will find happiness.
Many Americans believe in the interminable joys associated with great wealth. They think that the sooner they achieve fame and fortune, the sooner they will enter the exclusive club of perpetual nirvana.
But wealth creation takes time, while asset price inflation takes a loose central bank. So America has chosen asset price inflation over true wealth creation. The speculator has replaced the investor. We day trade, flip condos and buy options.
Instead of picking up a copy of Benjamin Graham’s The Intelligent Investor, today’s investor shuns returns below double digits. Earning 9% won’t cut it if someone else is earning 10%. Stock markets have morphed to symbolize divine measures of prosperity in every form. And when Mr. Market doesn’t treat you well, you turn to Dr. Fed. And with the flip of a switch, he can quickly whip Mr. Market back into shape, or so we’ve come to believe.
The concept of wealth creation is Free Market Investor’s core theme. Our friend Marc Faber wisely points out, "It is important to distinguish between wealth creation arising from increased market valuation (asset inflation) and wealth creation through saving and investments."
As my former colleague the late Dr. Kurt Richebächer opined:
"American economists have never been as strict as European economists in making this distinction in wealth creation between rising market valuations and rising capital stock through saving and investment. Yet what has happened lately in this respect puts economic reason on its head. Protracted house price inflation, deliberately engineered by the Fed, is presented to the public as a virtually wondrous new policy stance in creating wealth and economic growth. It is hard to believe that such a grotesque perception is possible."
Focus for one moment on the premise that societies accumulate wealth slowly over generations. A true return on invested capital, like a tree growing in a forest, takes time to bring to fruition. Some investments, naturally, produce better returns than others. The key: Find the investments that have the potential to produce the greatest returns with an acceptable level of risk. When those investments trade for less than their intrinsic value, the potential for above-average returns can be fully realized.
In the case for cultivating the black walnut, the asset most timber investors lack is the patience to sit quietly and let their superior investments develop.
If market timers and the financial media followed this advice, many people would find themselves searching for other work. Instead, many investment professionals make a handsome living opining the ebbs and flow of quarterly earnings guidance, despite the fact that 59% of Wall Street’s "consensus" earnings forecasts miss the mark by a mortifyingly wide margin. In such a world, a good timber company can easily go unnoticed.
for The Daily Reckoning
June 26, 2008
Christopher Hancock has spent the last two years doing investment research primarily focused on emerging markets, specifically China and Hong Kong. After working with Citigroup in Hong Kong on the challenges and opportunities associated with the forthcoming RBM flotation reform, Christopher left many of his friends behind and decided to return to the States to pursue a career in equity research.
Christopher’s desire to work for an independent firm led him to Agora Financial, where he now is the editor of Free Market Investor. Christopher travels extensively and utilizes his contacts across the globe to recommend the best international investments in the world right now for his subscribers.
People who believe that history repeats itself are asking themselves: Is this a rerun of the ’30s…or a replay of the ’70s. Is it a deflationary recession we’re rehearsing? Or an inflationary recession? How is this story going to turn out?
We look around. We don’t see any breadlines…and people aren’t dressed nearly as well as they were in the ’30s. But now people get their free food through plastic "Independence" cards…proving that they are 100% dependent on the taxpayer for their daily bread. And as for dress…what do we know? If people like wearing flip-flops, pedal pushers, and shirts with reptiles on them, does that change the plot or alter the outcome?
It doesn’t look like the ’70s either. No afro hairdos…no muscle cars…no polyester shirts. (We had one…a brown one with white stitching. It clung to our manly, young body and almost electrocuted us each time we took it off. Elizabeth threw it away the first time our back was turned.)
Still, the economy is beginning to look a little like the ’70s.
"Stagflation fears vexing Bernanke," says the Chicago Tribune.
"Spectre of inflation returns to global economy," adds a front-page headline on the Financial Times.
In the following reckoning we don’t disagree. But we add a much-needed nuance. Not only is the spectre of ’70s inflation haunting the economy…so is the spectre of ’30s deflation.
Check out this headline: "Biggest drop in housing since Great Depression."
Yes, dear reader, get ready for a whiter shade of pale, as the two apparitions join in a ghostly hullabaloo. To the question – which will be have, inflation or deflation? – we have consistently replied, ‘both.’ And la voila – here they are.
But we’re no longer alone in this opinion. Yesterday, the world’s greatest investor and richest man, Warren Buffett, agreed with us.
"Stagflation," he said, was becoming a bigger and bigger problem. "I think the ‘flation’ part will heat up and the ‘stag’ part will get worse."
The Financial Times saw its inflation ghost in the huge price increases announced by Dow Chemical and South Korea’s Posco. The former is America’s biggest chemical group; the latter is the world’s fourth biggest steel maker.
Meanwhile, said Mr. Charles Holliday, CEO of Dupont, and not putting too fine a point on it:
"Inflation is here big time."
You think you’ve seen inflation, said a spokesman for mining giant BHP Billiton. You ain’t seen nothing yet. On Monday another mining group, Rio Tinto announced a price increase of 96.5%. Billiton said that even that would not be enough; it signaled a price increase of over 100%.
"Now," as Crocodile Dundee might have put it, "that’s inflation."
"The sustained rise in the price of oil and commodities has hammered industries such as airlines and carmakers, and deepened fears of a global inflationary spiral as producers pass on higher costs to manufacturers and consumers," the FT figures.
The Reuters CRB index is up 45% in the last 12 months. So far this year oil is up 42%. Natural gas has risen 76%. Corn has popped 58%. Soybeans 26%. Base metals are up about 30%.
Buffett is right…the ‘flation’ part is heating up. You see it in the newspapers, the check lines and, prominently, at the gas station. But what about the ‘stag’ part?
*** We live in a world powered by fossil fuel and designed – particularly in America – for a time when it was cheap and plentiful. Too bad that world no longer exists. Instead of building the world of the future, we built the world of the past. Now, we have to turn our backs on it, move on, and rebuild. This time, we have to build a world designed for oil that is significantly more expensive.
"Our civilization is based on fossil fuel," writes Martin Wolf in the FT. "But since the end of 2001, the real price of oil has risen some six-fold. Today the real price is higher than since the beginning of the previous century."
How expensive will it get? We don’t know. Our guess is that it will go down, not up, but still end up about twice as high as the price five years ago. T. Boone Pickens says oil output worldwide is peaking out. And never before have Americans had to compete with so many other people for it. Back in the early 20th century, a roughneck could sink a well in West Texas and have the oil all to himself. Now, there isn’t much oil left in Texas…and what little there is has to be shared with three billion people, many of them with incomes rising a lot faster than ours. If Pickens is right, it stands to reason that the price will probably be higher than it used to be – in real terms.
That prices are rising in nominal terms should come as no surprise either. For many years, central banks have increased money supply faster than the rate of GDP growth – often several times faster. Now that this monetary inflation is turning into consumer price inflation, no one likes it very much. But the only way to stop it is the Volcker way – that is, pushing up rates and forcing a recession. People would like that even less.
Already, the world’s capital markets are deflating. While prices for commodities and oil have risen steeply this year, stocks in Britain and America are down about 11%. Stocks in Europe have fallen even more – about 18%. And in Asia, markets have been beaten up and beaten down. The Shanghai market has lost 44%. Hong Kong is off 18%. And Vietnam has been whacked – down nearly 60% from the peak.
In America, the average stock may be down only a little more than 10%…but some industries have been hit much harder. Airlines, for example, are falling out of the sky. Finance is down about 40%. And homebuilding? Don’t even ask…
So, for now, the Fed isn’t fighting inflation at all; it’s fighting another ghost from the past – deflation. You don’t lend money at less than half the level of consumer price inflation if you’re fighting inflation. You only do when you see the ghost of the ’30s hard on your heels. Yesterday, the Fed must have looked back…seen the spectre of deflation…and decided to leave rates were they were.
*** Little noticed among all the noise and smoke is the way the two ghosts – of ’30s deflation and ’70s inflation – join forces.
As we explained yesterday, expensive energy is destroying the suburbs. That’s not all, as Americans are forced to pay more for fuel, they pay less for other things. The whole retail sector suffers. And much of the hospitality industry; this year Americans are planning on taking ‘stay-cations.’
The Fed tries to jolly things up with more money and credit, but what happens? Oh, cruel, cruel fate! The money feeds into other economies…and into the prices of commodities. Then, as fuel, food, and raw materials bills go up…the extra expenses weigh down the economy like a concrete block tied to a corpse in the East River.
Yes, dear reader, the ghost of ’70s inflation frightens the economy…only to be followed by the ghost of ’30s deflation. Between the two of them, they’re going to scare the living daylights out of us.
*** "Bill," began a message from our farm manager in Argentina, "we are in the wrong business."
Yes, we are in the cattle business – in Argentina, no less. Cattle prices have risen only 1% this year. South of the Rio Plata, the cattle business is worse. Farmers have been getting rid of cattle so they can plant corn, soybeans and wheat. Result: cattle prices have fallen. Often, it’s hard to find anyone who will even take the cows away. Why? Because buyers can’t get them to market, since the grain farmers have blocked the roads into Buenos Aires.
That’s the nice thing about being a grain farmer, you have time on your hands. You can hang around a roadblock…or go give your congressman a fright. Not so with dairymen and cattlemen. They’ve got to stay near their animals.
Yesterday, apparently, the blockades in Argentina were lifted…but we doubt we’ll see much pick up in the beef market.
The Daily Reckoning