Can an Understanding of the Global Commodity Market and International Trends Assist us in Timing our Harvesting Better?

From time to time, when clients are searching for the elusive answer to what is the best time to harvest, we get into some pretty detailed discussions about global trade, commodities and economic cycles. For those of you interested in such matters, we are going to venture (briefly) into this esoteric world and see what wisdom we glean to make us better decision-makers.

Let's look at how closely timber prices (represented by US D fir log exports) are correlated to the price of another widely traded global commodity - metals. The first thing we note is a lack of correlation between metal prices and D fir log export prices - see chart below. 

  1. From July 1988 to July 2000, there are predominantly strong negative correlations.
  2. From August 2000 to August 2005, there are predominantly positive correlations.
  3. Very mixed correlations from August 2005 to July 2009, and high volatility.

The negative correlations shown above are also exhibited in the value of timberland. Timberland assets are sometimes sought after as part of a balanced portfolio because they exhibit this negative correlation to the market (and lower volatility). They can increase the returns on a portfolio without increasing its risk (beta). Whilst this can be observed empirically, explaining this phenomenon is more difficult.

However, causal factors are believed to include:

  • The biological growth of forests means that the opportunity cost of holding forests during periods of weaker prices is lower than holding (dead) assets such as metals.
  • The period of time from inventory to market is (usually) relatively short (mature standing forests, compared to delineated mineral resources - "pounds in the ground").
  • Market segment affect: a significant amount of logs and log residues are used in pulp and paper manufacture. Pulp and paper up-cycles can drive higher harvesting levels, increasing supply of saw logs (weakening saw log prices) but overall returns from harvesting are balanced by the higher pulp log and residue prices. The reverse happens during economic downturns.
  • At higher prices, timber is highly prone to substitution from metals (principally steel and aluminium), concrete and plastics/synthetics. This limits price elasticity.

Having said that, log prices in New Zealand, exhibit much more volatility. This is due to:

  • Strong (and increasing) reliance on the export log market - see chart below.
  • High volatility in NZD:USD exchange rate.
  • High volatility in Ocean Freight rates.

The chart below shows why the export log market is important and why it will increase in importance. The only option for the increased harvest will be to export the logs.

Note: At present there is little evidence that the even modest forecast of increased domestic consumption assumed in this chart will eventuate.

The increase in log availability is much more pronounced in some regions (see chart below reproduced from the article above). Northland, Gisborne and the Southern North Island, for example, will experience significant increases in log availability in relatively short time-frames. There regions also have particularly challenging harvesting contractor availability and log handling and log storage constraints even with present harvesting volumes.

Wood Availability Forecast from Ministry of Agriculture and Forestry for Period 2007 to 2049 - East Coast Region.

The chart below, courtesy of Agrifax, demonstrates the volatility in price of an industrial export log (KI grade). Due to the above factors, this volatility is typical of all NZ export log prices.

Agrifax Log Price Series (NZ$/JAS at-wharf-gate) for Industrial Export Log KI Grade

New Zealand also hits capacity constraints quickly in a market upturn. During the infamous price spike of 1993 (seen above in the D fir chart, and experienced in an even more pronounced way in New Zealand), harvest volumes increased relatively little, despite prices soaring. The main capacity constraints are:

  • Availability of Harvest-Ready forests - lead times to harvest are increasing as we are moving into more remote hilly country.
  • Availability of harvesting contractors.
  • Availability of trucks and drivers.
  • Availability of port infrastructure, especially low-cost log storage.

Summary and Conclusion

  • Studying global trends in commodities is interesting but forecasts based on past performance are unreliable. The international log and timberland market is often negatively correlated to other commodities and economic cycles.
  • International experiences and trends do not necessarily apply to New Zealand forestry and harvesting and marketing.
  • New Zealand has some unique features such as higher log market volatility and production capacity constraints.
  • Whether large or small, forests that are Harvest-Ready will be in a stronger position to maximise returns:
    • If large, at least start harvesting during an uptrend; engage capable and experienced harvesting contractors (a big determinant of returns) and have the option of suspending harvesting if a pronounced downturn occurs.
    • If small, start and perhaps complete harvesting during an uptrend with a capable and experienced harvesting contractor.
    • Near-mature forests on PF Olsen's books enables us to get ahead with critical harvest planning and better provide infrastructure such as contractors and log handling facilities at ports. It also assists us in developing markets for the logs.

Being Harvest-Ready is a means of increasing the liquidity of your forest asset and making the decision to harvest concurrent with the ability to harvest. If you would like to find out more about getting your forest Harvest-Ready please contact your local PF Olsen representative, or call us on FREEPHONE 0508 PFOLSEN (736 5736) or email us at info@pfolsen.com or visit our website www.pfolsen.com.