Lumber, Year's Best Performer, Enjoys Its 15 Minutes

A log moves along the conveyor belt for processing in Idaho Forest Group’s Athol, Id. sawmill.
Kate Kelly | CNBC
A log moves along the conveyor belt for processing in Idaho Forest Group’s Athol, Id. sawmill.

Athol, Id. — Standing inside the "merch," a cramped control room overlooking one of their sprawling sawmills in early December, Erol Deren and Mike Henley watched spruce logs shooting down a conveyer belt for cutting.

Spruce had been a good performer of late for their employer, Idaho Forest Group, but the men were switching to white fir, a higher-quality spruce substitute, the following week.

Such optionality is a welcome break from the environment back in 2009, when a bottoming lumber market meant that inventory-clearance drove most processing decisions.

"In the last few years, it was what we could sell," recalled marketing and sales head Deren, who meets every Monday with Henley, who manages two of the company's plants, and other colleagues to plan the week ahead. "Right now, we can look at maximizing profit."

IFG, North America's 12th biggest lumber producer by capacity, according to figures from the industry consultant Forest Economic Advisors, isn't the only timber company experiencing a renaissance. Since March 2009, when the physical price of lumber hit a low $195, the market has come rocketing back, rising 87 percent to $365 in recent trading, according to the trade publication Random Lengths. This past year alone, physical prices rose 40 percent, and futures prices for lumber rose 49 percent — making lumber the best-performing commodity on the CME.

Lumber's recent performance "has exceeded almost everybody's expectations," said Craig Hamanishi, an analyst at INTL FCStone who counts IFG as a client. "Nobody expected these levels."

The upswing has been driven by a number of factors — added demand from Asia, reduced supply — but perhaps most importantly, improved housing starts, which rose 20 percent through November of last year and have nearly doubled since their bottom. And numerous industry executives and analysts remain bullish, with 57 percent of the physical lumber traders recently polled by Random Lengths predicting continued strong increases in housing starts in 2013.

"Despite all the worries about the fiscal cliff, Europe, the U.S., Middle East, the outlook for wood products is upbeat," said Shawn Church, the publication's editor. "Who knows if all this optimism is misplaced, but it's definitely out there."

A processor machine removes branches from felled trees in an Idaho forest.
Kate Kelly | CNBC
A processor machine removes branches from felled trees in an Idaho forest.

Even so, it can take many months to rehire and reopen closed facilities — a reality IFG, which is considering adding shift hours to the Laclede, Id. mill it idled during the downturn, now faces. (Read More: Commodities Four-Year Winning Streak May Be Over )

"The decision to drop a shift or to reduce one is a big one," said Hamanishi. "You cannot ramp up production as easily as you would want to based on good levels. You can't get the logs out of the bush as fast as you might want."

Top Lumber Producers by Capacity, 2012

1 West Fraser Mills Ltd. 5604
2 Canfor 4746
3 Weyerhaeuser Can 4585
4 GP Koch 3291
5 Sierra Pacific Ind 2369
6 Tolko 2237
7 Res For Prod 2131
8 Hampton Lumber Mills Inc 2014
9 Interfor Pacific 1700
10 Simpson Tim Co 1428
11 Western FP Inc 1360
12 Idaho Forest Group 1185
Forest Economic Advisors, LLC

IFG's executives are aware of the risks, but said they see limited downside. Because of changes they were forced to make in 2009, domestic home construction now accounts for only about half their volume (down from 90 percent). They've also rejiggered their focus to include speciality products, like cedar for decking and siding, in addition to mainstays like white fir and hem fir.

It's all a bold bet on the future, and one that the futures market is indicating might be a little overblown. Lumber futures have been trading in backwardation (or at lower levels than their physical counterparts) in recent weeks, and some analysts predict a leg down in the cash market this year. (Read More: Will Gold Shine in 2013?)

Still, with the cost per physical unit estimated at $270 and today's benchmark sales price roughly $100 higher, margins remain fat.

—By CNBC's Kate Kelly; Follow her on Twitter: @KateKellyCNBC