VARDAMAN VIRTUAL FORESTRY COMPANY

The Most Direct Link to Knowledge Workers in the Southeast Forest Economy

TODAY'S SCIENCE: THE CURE FOR HARD TIMES

Everyone is now talking about recession, depression, lack of consumer confidence, and lay-offs, and most timberland owners recognize that conditions in the national economy will eventually control timber prices. Our price graphs show this. Although we don't claim a high level of sophistication for them, you can see that the JMV&CO index of pine stumpage prices moves more or less with the "Random Lengths" Lumber Composite Price Index, which indicates the level of lumber prices, which in turn reflects general economic conditions. Consequently, in the present state of the national economy, we will be lucky if present price levels hold; there is certainly no boom in sight.

Graphs of the two indexes, which are not adjusted for inflation, and other economic indicators also reveal that conditions usually do not remain unchanged at any level. If you missed one good timber market because of a recession in the past, all you had to do was wait a few months until the economy recovered, and you would have another chance. Therefore, some timber sellers are now asking, "Is the current situation like other recent ones?"

So far as we are concerned, the most logical answer comes from S Jay Levy*, author of "Profits and the Future of American Society" and for 43 years publisher of "Industry Forecast," a monthly newsletter. Levy points out that we are in a depression, not a recession and that there won't be a quick recovery. Here's a quote from the latest "Industry Forecast:"

Many officials and independent observers assert that the economy is recovering, albeit slowly, while others raise doubts. Yet the issue is not when the economy will experience its usual post-recession recovery, for such a recovery will not materialize. Rather, at issue are the length and severity of the contained depression. Any periods of expansion during this troubled period, and there will be some, will be stunted and interspersed with periods of stagnation and contraction.

"The primary imbalances in a recession," said Industry Forecast a year ago, "are inventories; in a depression they are structures and productive capacity. Inventory imbalances can be corrected quickly; excess structures and capacity take years to absorb." The inventory excesses that developed as the economy sagged in the summer and autumn of 1990 were not great and could quickly be corrected. Hence the "recovery" during the spring and summer of 1991.

But the excesses of structures and industrial capacity have become greater since the business cycle peak in July 1990. Industrial capacity utilization is down almost 4%. Office space vacancy rates are higher than they were fifteen months ago. Consumers are reducing their spending, certainly in real terms. Business distributors and producers are struggling to keep stocks down in the face of less-than-expected sales. The economy is hardly poised to regain upward momentum.

If Levy is correct about the next few years, and he has so far been right about the duration of our present troubles, timberland owners face some serious questions. Without attempting to provide the best answers, we have discussed them below.

A tax cut won't solve the main problem facing the national economy, so if it materializes, the only important aspect will be its effect on each individual. At present federal and state taxes on gains from asset sales amount to 35% for most persons. Consequently, when you sell $1,000 of timber and your cost basis is zero, your gain is $1,000, and you get to keep $650. If the legislatures, in an unprecedented burst of generosity, cut 1992 taxes by more than a quarter to a total of 25%, you could keep $750 by delaying the sale until then.

But as we all know, nothing stays the same, certainly not prices. In today's environment, while you are concentrating on taxes, prices are quite likely to fall 10%. Then your timber would bring only $900, but you would get to keep 75% or $675, IF the talked-about tax cut becomes reality, so you would make $25 or 3.8% by waiting a year. (This calculation assumes that you have zero cost basis; since your cost basis can be recovered tax-free, the $25 would be smaller if your cost basis were higher.)

So the only answers to the question are more questions: How likely is a tax cut? How big will it be? What will happen to timber prices in 1992? And there is one more:

These questions are easy to answer. Any forester with an increment borer, a little time in the woods, and a pocket calculator can determine how much your present stand is growing, and you can make the same assumptions as above about future timber prices. If you have been reading our newsletters for the past few years, you already suspect that natural stands probably earn 5% to 6% on the value of merchantable timber and nothing on the value of the land they occupy and that the same thing is true of stands planted at very close spacings. But don't base your decision on what we reported in a free newsletter. Spend a little money on a forester, and find out for sure. When you get the report, don't forget to reduce the value of your property by the 35% over your cost basis that already belongs to the governments. This is no longer yours.

What can you do with the cash that can be realized from selling your property? Jim Vardaman's Kemper Money Market Fund, on which he can write checks, paid an annual return of 4.96% during the 31-day period ending on 26 October 1991, but you can surely beat that. His other favorite is Tri-Continental Corporation, a closed-end investment company whose shares are traded on the New York Stock Exchange. It has paid consecutive quarterly dividends since 1950 and, for past periods ending on October 31, earned returns of 18.9% over ten months, 11.2% over five years, and 15.5% over ten years.

Is it? In our October issue we published the annual inflation rates since 1979 and showed that they averaged 5.49%, while our index reveals that timber prices remained essentially unchanged. If these conditions remain the same, how can timber investments be a hedge against inflation: Indeed, in the same issue we described a recent study that showed real price declines for all types of timber during this period. The only way to maintain the purchasing power of income from timberland is to speed up the production of timber products.

Obviously, the Kemper Money Market Fund isn't an inflation hedge either; all savvy investors have long known that ash or its equivalent has been a loser except in times of deflation. Only productive enterprises like those whose shares are owned by Tri-Continental Corporation can beat inflation.

The status of timberland as a poor investment isn't exactly a secret. Lobbyists of one kind or another have been begging federal and state legislatures for subsidies for at least half a century, and they are at it again. In November an Associated Press story from Washington reported that members of both parties introduced identical bills in the House and the Senate to help the timber industry recoup some of the tax benefits it lost with the passage of the 1986 Tax Reform Act. Quoted or mentioned in the story were Rep. Lindsay Thomas and Sen. Wyche Fowler of Georgia and indicated the thrust of the effort when he said, "If you run the numbers on investing in reforestation of woodlands today, it just doesn't wash".

All four men seem to be anxious to spur investment in reforestation or timberland, and we must accept that they believe what they say. But we are forced to ask, "If you owned capital, would you invest it in a medium that is as bad as they say it is, one so bad that it requires a government subsidy?"

We believe that they are wrong and furthermore that, if the government subsidizes practices as bad as some that it has subsidized and continues to subsidize, these bills will do more harm than good. They will be chunking your money and ours down an unproductive rathole.

The only effective solution to these problems on all levels is to get money out of unproductive media and into productive media. We don't know what to do with vacant shopping malls, office buildings, or apartment houses, but the route is as plain as day in timberland. You need only apply the tried-and-true practices that we have been writing about for years. In other words, use today's science in today's investments. Lifting the return on the land component of such investments is impossible by any other means.

When you employ these new techniques, you'll need no government subsidy to do as well as Tri-Continental's investment managers. And you do your part to solve the country's problems. If you doubt that these results can be obtained, we will show you the documentation; if you don't believe the documentation, we will show you the trees.

*For ten years we have used Jay Levy and his publications to learn about the national economy and strongly recommend them. You can get in touch with him at PO Box 27, Chappaqua, NY 10514 or 914+238-3267.