Timber on Fire?

The Journal this morning noted huge demand from emerging markets, namely China, driving material costs through the roof. I have talked in the past about the risk in certain commodities, when it comes to large shifts in demand here at ONN and on CNBC and also how traders can take advantage of rising or falling commodity prices using futures, ETF’s and options.

Earlier in the week, a trader was using a risk reversal (long call, short put, different strikes) in WY – Weyerhaeuser to synthetically get long stock ahead of its earnings. The trader bought the January 55 call and sold the January 40 put for even. This means they did not pay or collect anything to do the trade. The risk reversal is now worth 65 cents, representing a small, but tidy profit in a short time on this trade, which could have either been a straight risk trade or a hedge (the stock is up roughly $3). Regardless of the traders reasoning, WY stock is up 6 days in a row and continues to make new highs, currently trading at $52.66. Earnings are due out on April 29.

Today, WY added another 1.6% to its price in response to the strong new home sales data: Sales of new single-family houses in March 2010 were at a seasonally adjusted annual rate of 411,000, according to US census Bureau and the Department of Housing and Urban Development, this represents a 26 9% increase above the revised February rate of 324,000 and is 23.8% over last year’s March estimate of 332,000. The median sales price of new houses sold in March 2010 was $214,000; the average sales price was $258,600.

WY is both a grower and processor of timber, in many different forms and products from pulp/fiber, to building materials to packaging and shipping. Rapidly rising lumber prices will certainly have an effect on profitability and margins. To ebb and flow with pricing, WY can obviously raise/lower the prices of their products. But the question is how fast can this be done and are their contractual restrictions with their customers? I contacted Weyerhaeuser for comment, but they are currently in a quiet period ahead of their earnings report, I hope to get more color on these topics in the coming week.

The jest of the Journal’s article was the fact that higher material prices was having an adverse effect on manufacturing companies like Bridgestone and Goodyear who use rubber to produce tires, rubber is up 74% year to date.

Homebuilders like Lennar Corp. and Ryland Group may also be negativity affected as they are struggling to keep home prices attractive amidst a 59% jump year to date in lumber costs, the countering force there is an increased consumer demand for homes, which today’s report is showing, at least for now.

Another timber company that reports earnings next week, on Monday, is Plum Creek, who according to their website is the most geographically diverse private landowner in the nation. This not only makes them a huge lumber producer, but also gives them ownership of what is in and on the ground below the trees, namely rocks, sand, minerals, oil and gas, which may also be of value. Plum Creek’s stock has also seen a sharp move upward this week and continues today on the strong housing numbers. With earnings due out Monday, options traders can use calls and puts to take advantage of a possible move upward or downward. Apparently, market participants this week seem to be bullish on PCL going into the report. Sometimes a stock that is pricing in perfection can be more susceptible to disappointment when it comes to the actual report.

While higher material costs may be bad for the companies that utilize the end product, the producers may stand to benefit, if they can capture the right prices.