Gold News

Sell Pine, Buy Walnut

A true return on investment takes time to bring to fruition...

METAPHORICALLY SPEAKING, most stock market investors plant Loblolly pines, says Chris Hancock for The Daily Reckoning.

   They should be planting walnut trees instead.

Recently, my father-in-law hired a timber consultant to appraise the value of a large tract of timber he wants to harvest along the Mattaponi River in central Virginia. Before we went to meet him, my father-in-law told me:

"This guy's been in the business for years. He knows his stuff."

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 knew black walnuts are worth considerably more than any species of soft Virginia pine.

"Black walnuts? You wouldn't want to do that," he said. So I pressed him for a good reason why not.

He rubbed his beard for a second and said, "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."

To be honest, 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 kids quickly comprehend the meaning. There's never a "dumb question"...just 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. And 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.

"About $100..."

"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, Gold or even real estate 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 that, over a 30-year period, a walnut harvest will generate five times the return as an investment in pine.

        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. And 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. Because 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 helped form 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.

   But wealth creation takes time, while asset price inflation simply 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. Not even for a single year!

   Earning 6% just doesn't cut it for the instant gratification society, especially if someone else is earning 12%. And when Mr. Market doesn't treat you well, you turn to Dr. Fed for help.

   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 the core theme for Free Market Investor, my advisory letter. 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...over time.

   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.

Christopher Hancock has spent the last two years doing investment research primarily focused on emerging markets, specifically China and Hong Kong, working with Citigroup in Hong Kong. Now editor of Free Market Investor for Agora Financial, he continues to travel extensively and use his contacts across the world to identify strong international investments.

Chris Hancock articles

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