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Investor Interest returns to forest products equities

Investor interest in forest products companies is re-emerging, after a lengthy lull. The TSE Paper and Forest Products Index has advanced by almost 29% from its low in late August 1998 through March 19 and has been the strongest performer of any TSE group since late 1998 (up 14.8%). In the US, forest products’ equities have also outperformed the S&P 500 since December.

Sentiment is turning more positive for commodity markets. Investors are anticipating a slow recovery in Asia and the beginning of a synchronized pick-up in global growth by the spring of 2000 — developments which will help to boost commodity prices.

The US entered 1999 with considerable economic momentum, following a spectacular 6.1% annualized GDP gain in 1998’s fourth quarter. While Japan remains in the doldrums — recording a 0.8% decline in fourth quarter GDP — consumer spending and housing starts have inched up in recent months.

Financial conditions have improved substantially in South Korea, Thailand, Malaysia and the Philippines since last fall — trade and current account deficits have been reversed, currencies have appreciated substantially against the US dollar and interest rates have fallen back to single-digits. In the case of South Korea, the won has retraced roughly half its 47% depreciation from mid-1997 to January 1998. The severe depreciation of the won had virtually halted imports of some resource products such as pulp in early 1998. However, the recent appreciation will boost the affordability of raw material imports.

Though the recovery remains fragile, South Korea, the world’s eleventh biggest economy and a major importer of raw materials, shows definite signs of turning around. A huge improvement has occurred in the Korean balance of payments. Gross foreign exchange reserves reached a record high US$53.6 billion at the end of January 1999, up more than US$30 billion from the crisis levels of late 1997. While this largely reflects import compression due to weak domestic demand, export receipts also started to pick up in early 1999. Consumer spending appears to be turning around, with a large year-over-year jump in auto sales in January. S&P upgraded Korea’s long-term sovereign foreign currency debt to an investment grade BBB- in January.

In February 1999, Scotiabank’s All Commodity Price Index — a trade-weighted U.S. dollar-based Index of key Canadian commodity exports including forest products, metals and minerals, oil & gas and agricultural products — remains 19% below its May 1996 peak. The Forest Product Sub-Index — a trade-weighted index of lumber, pulp & newsprint prices — is also 15% below its previous November 1996 peak. However, both indices have moved ahead in recent months. The All Items Index is now only 2% below a year earlier compared with an annual decline of 11% at the recent low point last October. The Forest Product Index has advanced by 1.3% year-over-year, largely on the strength of US housing starts and lumber prices.

Global market conditions remain challenging for pulp and paper products, with newsprint prices still edging down in the United States. Significant capacity expansion also poses a near-term risk for newsprint prices in Europe. However, investors are probably anticipating the beginning of a sustained recovery next year. In the new millennium, recent restructuring and cost cutting bodes well for Canada’s newsprint and groundwood specialty paper producers.

Pulp producers will probably be successful in boosting US and European transactions prices for northern bleached softwood kraft in the spring. Swedish and Finnish pulp producers in mid-March announced a list price increase from US$460 to US$480 per tonne, encouraged by the February decline in seasonally adjusted Norscan inventories and increased shipments.

The Norscan shipments-to-capacity ratio for chemical pulps averaged 97% in February, indicating a tight market. Increased volumes to Asia reflect buying at bargain prices and replenishment of Korean inventories. Asian papermakers are also building up hardwood pulp stocks to supply new paper machines in China and Indonesia — a development which has dramatically tightened Asian hardwood markets. While some of the recent increase in Norscan shipments may borrow from orders later in the year, a sustained recovery in pulp markets is expected by 2000. P&PC

Patricia M. Mohr is Vice-President, Economics, Scotiabank, Toronto, ON.