The inflation numbers, as reported by the government, remain at acceptable levels for the Federal Reserve and investors. However, does anyone really believe that inflation, as measured by the consumer price index (CPI), increased by only 2.9% over the last 12 months?
As consumers, we regularly go to the grocery store and fill up our tanks with gasoline. The prices of many food items have increased in the double-digit percentages over the last year. Some example of price increases includes coffee (+31%), peanut butter (+22%) and flour (+16%). And there is no denying the rise in gas prices, which have doubled since Obama took office in 2008. In my opinion, inflation is here and will only increase in the coming years. (For more, see Earning Forecasts: A Primer.)

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Timber Hedge
When it comes to hedging investments during an inflationary period, the fan favorite is often buying gold of Treasury Inflation Protected Securities (TIPS). While both should outperform the overall market during high inflationary times, one often-overlooked sector is timber and land stocks.

As inflation increases, the value of the land will also increase, thus making the companies that own the timberland a place to put money was the value of your dollars are declining. Investors could go out and buy some timberland and sit on it until the value rises, but that requires large amounts of cash and a lot of time and effort.

Another option is timberland stocks and ETFs that will be less costly and are liquid in that they can be sold on the open market for a minimal fee.

Timber ETFs
The iShares Global Timber & Forestry ETF (Nasdaq:WOOD) is composed of 24 of the largest publicly traded companies in the forest and timberlands industry. Half of the allocation is invested in stocks based in the U.S., followed by 18% in Scandinavian countries. The top holdings are Weyerhaeuser (NYSE:WY), Rayonier (NYSE:RYN), and Plum Creek Timber (NYSE:PCL). The expense ratio is 0.48% and the 30-day SEC yield is 2.8%. Year-to-date the ETF is up 14%.

The Guggenheim Timber ETF (ARCA:CUT) is composed of 31 stocks. The U.S. accounts for 40% of the ETF, followed by Japan with 18%. The top ten holdings have some overlap with WOOD. However, there is a heavier concentration of international holdings in CUT. The expense ratio is 0.65% and its dividend yield is 2.05%. The ETF is up 11.5% in 2012.

Timber REITs
A real estate investment trust (REIT) that owns timberland is an investment option that also offers an above-average yield. Both RYN and PCL are considered REITs that have a majority of their business coming from the timberland and products produced from that land.

RYN started out 2012 with a bang, rallying to its best level ever in mid-January before pulling back to support in the last six weeks. The $43 to $44 range is support for the stock, which has been able to hold above as it consolidates. The stock pays a 3.6% dividend and has a $5.4 billion market capitalization.

PCL also started out 2012 strong before pulling back to a support level. The major difference is that PCL remains well below its 2008 all-time high. That being said, the chart is bullish and an entry between $38 and $39 gives the investment a high reward-to-risk setup. The stock pays a 4.2% dividend.

The Bottom Line
The upside to investing in the timber sector is that inflation is almost certain in the near future and the charts are bullish. There are also the above-average dividends and the ability of the sector to join in on an overall equity rally. On the flip side, if inflation never creeps its way into the mainstream, it could hold back the sector. There is also the risk of a complete global slowdown that would hurt demand for paper goods that come from timberlands. Right now, the pros outweigh the cons. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.

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