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at the bell

Forestry analyst Paul Quinn predicts that U.S. housing recovery and Chinese demand will raises forest company stocks.JOHN LEHMANN/The Globe and Mail

Investors should always be on the lookout for a long-term financial trend, take a position early, and then ride it for all it's worth.

Such an opportunity could now be emerging in lumber, a long depressed commodity that could be on the cusp of better things. RBC Capital Markets' forestry analyst Paul Quinn believes that lumber is about to enter a "supercycle," or a lengthy period of buoyant prices.

He made the forecast in a recent report on the bullish long-term prospects of West Fraser Timber Co. Ltd., the West Coast-based forestry giant that is North America's largest lumber producer.

Mr. Quinn believes the U.S. housing recovery will be vibrant enough by the end of next year to put a strong bid in the market for lumber. Another bullish factor is that China has entered the demand equation as a big buyer of North American wood. Although it's now working down high stockpiles, this is temporary and the country will soon need to replenish holdings.

On the supply side, there are other trends that could drive lumber prices higher. Mountain pine beetles have chewed through British Columbia's forests. While this is an environmental calamity, the upside is a reduction in the supply of high quality wood. Governments in Eastern Canada are reducing the allowable cuts, another plus.

Mr. Quinn cautions that the supercycle isn't here yet, but is tantalizingly close. He once thought the highly bullish scenario wouldn't arrive until 2016-17, but he's done a reappraisal, believing it will start much sooner. "Given the acceleration in the U.S. housing recovery, we now believe conditions will be ripe by the end of 2014," he says.

To be sure, the forecast for a sharp rally in lumber as a play on the recovery of residential construction isn't exactly a new idea. In April lumber surged to a 9 1/2year high on just those hopes.

But the rally didn't have staying power and prices have since tumbled. They're off about 25 per cent from the recent highs, as a cold spring in the United States led to a drop in housing starts, while producers ramped up production.

The bullish case is built on a view that this price drop is an opportunity, a short-term downdraft that will be later seen to have been a good entry point for investors.

Besides West Fraser, other prominent names in the sector are Canfor Corp., International Forest Products Ltd., and Ainsworth Lumber. For the more speculatively minded, there are also lumber futures in the United States.

RBC isn't the only bank to have kind words about the outlook for lumber. Toronto-Dominion Bank economist Dina Ignjatovic issued a report last week contending that the "lumber price correction will not last." She thinks prices will rise by 30 per cent by the end of 2014.

"Despite recent trends, the outlook for the lumber market remains bright," she said.

The prime bullish factor is U.S. housing starts data. Starts are now running at about double the levels following the crash. But even this pace of building may not be enough to keep up with the demographics of family formation.

Ms. Ignjatovic says U.S. single family starts are about 40 per cent below the level required by demographic fundamentals "suggesting that the U.S. housing market will continue to be a key support for lumber demand and prices going forward." Canada is also the largest lumber supplier to China, and demand in the Asian economic powerhouse is also expected to remain strong.

Together the two countries about for about two-thirds of Canada's shipments.

With decent weather, it's unlikely that lumber will fall further and Ms. Ignjatovic says it is finding a floor.

Industry operating rates are rising sharply. Last year, they were more than 70 per cent, far better than the 56 per cent in 2009 after the crash. "All told, we forecast lumber prices to bottom in June before resuming an upward trend throughout the remainder of our forecast period as the market tightens," she said.

Mr. Quinn upgraded West Fraser to "outperform" from "sector perform," based on his outlook for lumber prices, and has a $100 price target. He previously preferred playing lumber through undervalued junior producers, but thinks the arrival of the supercycle makes unlevered, bigger companies the better buy. Part of the reason is that the big companies, with the ability to finance acquisitions, are going to benefit from consolidation, which will drive their profits even higher.

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