Editor’s Note: As I work to continue adding value to this publication for my subscribers, I am broadening my coverage of the resources sector beyond just metals and mining. Rest assured, metals and mining will continue to figure prominently in my coverage universe. However, thanks to growing global resource demand, profitable opportunities abound in everything from food and water to energy and timber. I would be remiss in not addressing these exciting new developments. Timber prices in particular have been surging lately, compelling me to devote this issue to global wood demand. — Benjamin Shepherd

Thanks to rock bottom interest rates and a gradual but steady improvement in US employment, activity in the housing sector has been picking up. Americans once again feel comfortable buying and refinancing homes.

While still nowhere near its pre-crisis high, the US real estate market has been steadily recovering over the past few years, as the stock of homes for sale has declined and real estate values in some of the hardest bitten areas are on the ascendency.

After construction ground to a virtual halt in late 2009, the stock of new homes for sale remained relatively static until late 2011. It has been steadily declining ever since, with the stock of existing homes for sale now at its lowest level in 13 years.

As you can see in the graph below, this trend has driven a solid recovery in home construction activity, which has nearly doubled off its 2009 low. This past February, US builders started new housing units and obtained building permits at the highest rate in more than 4 years.



The strong gain in permits issued, at their highest level since June 2008, is a sign that construction activity will likely remain strong in the coming months as supply tightens, proving the US housing recovery a durable trend.

At the same time, the number of homeowners who are underwater on their mortgages—those who owe more than their homes are worth—is also steadily declining. According to CoreLogic, a real estate research company, the number recently fell to 21.5 percent of households, down from 25.2 percent at the end of 2011. Home equity greatly reduces the risk of foreclosure, because it allows homeowners to refinance, but it’s also a common source of funding for home renovations and upgrades.

That’s obviously good news for the US construction industry and retailers such as Home Depot (NYSE: HD), which has seen its share price more than double since bottoming out in 2009. It also contributes to a positive price environment for timber, which recently hit an eight-year high in the US.

But in the rest of the world, timber isn’t fetching such a rich price yet.

The World Bank maintains a global index of timber prices, updated monthly, as part of its development indicators data. After a run up beginning in mid-2010, fueled by improving confidence in the global economic recovery, the index has steady declined since August 2011 (see graph below). Most of that decline can be attributed to the deepening recession in Europe and economic slowdown in China.



However, the index is likely to soon rise, based on the aforementioned improvement in the US housing and construction markets, as well as a rebound in Chinese demand for timber products.

China has long been the world’s number one importer of timber, which means an 11 percent decline in its import volume to 37.9 million cubic meters (m3) exerted a heavy drag on global timber prices. The net import volume of softwoods such as pines, typically used in the production of relatively inexpensive furniture and also items such as shipping pallets and paper, was particularly hard hit and fell by 15 percent.

Despite that full-year volume decline, Chinese timber imports staged a strong rally in the back half of 2012, retracing more than half of the ground lost in the first six months of the year.

Because of that demand improvement, environmental groups are reporting that forests in Cambodia are being clear cut at a dizzying pace, with most of the logs destined for China. Timber exports from the US states of Alaska, Washington, Oregon and California also shot up by 9 percent in the third quarter of last year, with more than 60 percent of that volume destined for China.

Chinese manufacturers have also picked up the pace of their purchases of rare hardwoods from Africa and pine from New Zealand. Moreover, Chinese timber purchasers reportedly have ventured into Montana in search of sufficient supply.

And supply has become the real driver of timber prices.

As US construction ground to a halt in 2008 and 2009, and the Chinese curbed their own building boom in a bid to tame soaring inflation in 2010 and 2011, global logging activity slowed sharply and lumber mills around the world shut down.

Nearly half of the mills in the US ceased all work between 2008 and 2010, while most of those that remained in operation only ran at about 60 percent of capacity, according to data from the US Forest Service. But even as demand for timber and lumber products has picked back up, shuttered mills remain jittery about the fragile economic recovery. They haven’t been reopening and operational facilities have been slow to add shifts to meet demand. Smaller operations have also had difficulty securing financing.

Capacity is similarly tight in other major timber producing countries such as Canada, Brazil and Russia, providing further support to high timber prices in US.

That’s spurred a huge run in the S&P Global Timber and Forestry Index, which is heavily tilted towards US companies (see graph below). Regardless, I see additional upside potential for timber prices, particularly since the World Bank Timber Index is still at such a low level, as global prices struggle to catch up with those in the US.



I believe they soon will.

The Chinese timber supply situation has become so dire, the government there is actually taking steps to curb the use of chopsticks in the country.

It is estimated that it takes 20 million 20-year-old trees to meet China’s annual chopstick demand. To discourage the use of disposable chopsticks, the government introduced a 5 percent tax on them in 2006, but it had little success in curbing demand.

The Chinese are committed to planting nearly 100 million acres of new forest over the next seven years, to catch up with its own timber demand and to meet climate change reduction targets.

Considering that China imported more than 3.5 billion board feet in 2011, the latest year for which complete data is available, and its timber demand is forecast to grow by between 3 percent and 5 percent annually, supply is obviously tight if the government is going after chopsticks.

Consequently, while US timber prices are at an eight-year high, I believe that they will go even higher, given that the US timber industry’s export supply will tighten thanks to improving domestic demand.

The Canadians will also continue to contribute to global supply tightening, as the government there cuts allowable harvests due to a Mountain Pine Beetle infestation that has destroyed a huge number of pines. Because of that infestation, the allowable harvest was increased late last decade to clear out dead and dying trees. But now that the beetle seems to be in check, the government is now cutting the harvest to allow its forests time to recover.

I look for timber prices to continue their upward march over the next couple of years, making timberland one of the prime investments in the resources sector. For my top picks, see this issue’s Stock Spotlight.