What’s Driving The Timber ETFs?

by on April 28, 2011 | ETFs Mentioned:

So far, 2011 has been a pretty good time to be a commodity producer, as most natural resource firms have risen substantially to start the year. While some sectors of the market, such as rare earth metals and agribusiness, have posted impressive gains, the two funds representing the timber industry have been quietly among the leaders through the first four months of the year. These two funds, which are both up more than 10% on the year, have managed to become two of the three best performing ETFs in the Commodity Producers ETFdb Category so far in 2011–all despite a continued slump in the American housing market.

While the situation hasn’t been very positive in the U.S. market, demand has been surging in Asia–a factor that has likely kept timber prices afloat so far this year. In fact, despite the American slowdown, global wood consumption is up 20% in the first quarter of 2011 when compared to the year ago period. Two major Asian nations have largely been responsible for this surge; China and Japan. The booming economy and the sheer number of people in China has helped to increase demand for wood products in the country, especially as the nation continues to industrialize at a rapid pace. Additionally, reports of a new tax of Russian timber has forced China to look elsewhere, namely putting the pressure on North American timberlands to make up the difference. In fact, some reports suggest that China may have to import about 182 million cubic meters of wood by 2015, up almost 70% from its current levels. “You’re talking lumber, you’re talking pulp, and there are a lot of estimates out there and a lot of industry analysts sharing similar views, and at the end of the day this is just something we agree on in terms of increasing [Chinese] need and demand.” said Dave Lefebvre of Canfor Corp [see Commodity ETFs Get No Love From Investors].

On the other hand, Japan has become an even larger consumer of  wood thanks to the recent earthquake and the massive rebuilding campaign that the country will now have to go through. All of this rebuilding will take a great quantity of wood, and Japan will likely be forced to increase its timber imports dramatically.

However, the demand for North American wood products may stretch beyond rebuilding efforts and to other industries in the country that have been impacted by the loss of power from the nuclear plants. “There could be an increase in demand from Japan for wood products—both for reconstruction from the terrible damage caused by the earthquake and tsunami and, in the near term, to replace lost paper production at the significant number of pulp and paper mills in the impact zone,” said Marshall Thomas, president of F&W Forestry Services, Inc., suggesting that demand for U.S. wood could surge if it takes longer than expected to get everything back to normal in the hard hit country [See Japan ETF Investing: Volatility In Quake Aftermath].

If these trends persist–and other emerging markets continue to exhibit growing appetites for raw materials–the timber industry could be an interesting play that doubles as a potential inflation hedge. This is especially true given how low wood consumption had fallen immediately following the housing bust of 2008; some reports had global wood consumption at the lowest it has been in about 50 years in 2010. Yet, with demand now surging, it is very possible that prices may be moving quickly off of these recent lows. Furthermore, since many of the companies in these ETFs are either small or obscure, they generally do not find their way into many portfolios otherwise, making the funds interesting satellite picks in the near term. For investors who believe this might be the case, and looking for further exposure to the industry, the following two ETFs represent excellent options:

iShares S&P Global Timber & Forestry Fund (WOOD)

The slightly more popular of the two, WOOD has managed to haul in almost $300 million in assets to date. The fund tracks the S&P Global Timber & Forestry Index, which is designed to measure the performance of companies engaged in the ownership, management, or upstream supply chain of forests and timberlands. WOOD holds just 31 securities in total but manages to have a roughly 50/50 split between American and international firms giving it solid diversification from a geographic perspective. Top individual holdings include Sino-Forest Corp, Weyerhaeuser, Rayonier, and Plum Creek Timber [Do You Need A Timber ETF?].

Guggenheim Timber ETF (CUT)

Although CUT isn’t as popular as its iShares counterpart, the fund does have a much higher average daily trading volume, suggesting that it may be a more liquid choice for traders. CUT has even fewer securities than the other timber fund at just 27 in total, and this ETF maintains more of an international focus for its holdings; U.S. stocks make up just under 30% of the total. In terms of individual countries, beyond the US, Japan makes up about 18% of the fund while large allocations also go to Canada (9.5%), Finland (9.2%), and Sweden (8.5%). Possibly thanks to this heavier international focus, especially on Japan, CUT has managed to outperform WOOD so far this year by about 140 basis points, although both are up more than 10% on the year [Compare CUT to WOOD with our new ETF Comparison Tool].

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Disclosure: No positions at time of writing.