Timber Companies: A Trend Follower's Nightmare
By Ian Davis, editor, Quant Trader
April 7, 2008
Some sectors lend themselves beautifully to trend-following techniques.
Biotechnology, for example, is a sector that goes through huge booms and busts. The reason is simple: New, world-changing technologies are a sexy story. People at cocktail parties love to talk about life-saving drugs... life-saving drugs their investment is in the process of developing.
This excitement spreads like a wildfire.
When biotech stocks get going, they can rage out of control for months. The Datastream Biotechnology index exploded higher in four triple-digit (or more) rallies in the last 30 years.
Timber, on the other hand, is a nightmare for trend followers.
For starters, timber companies are perpetually unpopular. Cutting down trees conjures an image of wastelands and spotted owls with no homes. The sector rarely becomes the subject of cocktail parties, and never in a positive light.
Now, don't get me wrong, I'm not saying timber companies are never an attractive investment... They often are. However, the sector is unlikely to experience a snowballing, triple-digit rally like some of its sexier peers.
Take a look at the following chart...
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High Volatility Leads to Whipsaws, Making Trend-Following Impossible
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As you can see, the Datastream Americas Forestry Index looks "messy." Timber often experiences large volatility, and the trend is hard to decipher.
This is a poor situation for trend following.
If you try to buy after a sharp spike, you almost always get punished by a whipsaw. (A whipsaw is a term used to describe a "fake-out" for trend followers. Specifically, it's when a stock begins to rally – triggering a buy for these speculators – and then falls, forcing you to sell at a loss.)
When sizing up a trend, you must first figure out if the sector is well-behaved for trend following.
Throughout my research, I've discovered many great cyclical sectors. Timber's not one of them, so it's not suitable for trend speculating. However, timber is almost always in a slow, steady uptrend. You aren't going to make hundreds of percent in a year buying it, but if you want a sector you can buy and forget about for a decade, timber is a good place park some cash.
Good investing,
Ian Davis
