Winners and Losers From America’s Oldest Trade War

Matthew Carr By Matthew Carr, Emerging Trends Strategist, The Oxford Club

Market Trends

Since the U.S. presidential election, the media has provided wall-to-wall coverage of the dazzling performance of financial and tech stocks.

What’s been overlooked is that shares of companies at the center of America’s oldest trade dispute have been on a tear. They’ve gained as much as 68% in recent months.

But the dispute is not with China… nor any other low-cost producing country in Asia…

It’s with Canada.

And it has nothing to do with crude or pipelines or even the Northwest Passage.

It has to do with pine trees.

In April, we saw what appeared to be the first volley in a resurfacing trade war. Newly announced tariffs sent the price of Canadian lumber stocks surging.

Investors are now riding the heightened tensions to profits.

From just a couple days after the election through the end of April, shares of the world’s largest newsprint maker, Resolute Forest Products (NYSE: RFP), were up 68.8%.

Shares of Canfor Pulp Products (TSE: CFX), West Fraser Timber (TSE: WFT) and Western Forest Products (TSE: WEF) have all shown double-digit percentage growth in that time frame as well.

What’s more, the price of lumber has shot up more than 20% since Trump’s victory. Year to date, lumber is up 8.76%, outpacing the S&P 500 and the Dow Jones Industrial Average.

Investors should be asking, “What’s the reason behind this impressive performance?”

No Relationship Is Perfect: The Story Behind Lumber’s Surge

The U.S. and Canada have an important trade relationship. Cross-border trade between the two countries – consisting of mostly natural resources – totaled $545 billion in 2016.

But despite this robust figure, the trade relationship between the U.S. and its second-largest trade partner is hardly conflict-free…

And surprisingly, despite all the protests and debates over TransCanada’s (NYSE: TRP) Keystone XL pipeline, the most contentious issue between the U.S. and Canada is lumber.

Canada is the world’s largest lumber exporter (the U.S. is second-largest). Roughly 47% of that is northern bleached softwood, newsprint pulp and softwood lumber. Softwood is any tree that has cones, such as spruce, pine and fir. This type of lumber is important for building homes.

As with many other resources, the U.S. is the world’s largest importer of softwood. Remarkably, 78% of Canada’s softwood lumber exports go to the U.S. In 2016, this represented $5.66 billion.

As far back as the 1980s, U.S. lumber companies have argued that since Canadian lumber is subsidized, it has an unfair advantage in the marketplace. Canada argues that without its exports, the U.S. couldn’t survive. Plus, Canada’s softwood exports are mostly from just one province: British Columbia.

In 1996, the U.S. and Canada signed the Softwood Lumber Agreement. This set quotas on Canadian imports and established tariffs. The agreement was renewed in 2006, but it expired in October 2015. The following year, Canadian lumber was shipped tariff-free into the U.S. while negotiations were underway.

After Trump won the election in November, the U.S. lumber industry urged the government to re-impose tariffs.

The price of lumber shot higher as this seemed a likely outcome. This was confirmed at the end of April when U.S. Commerce Secretary Wilbur Ross stated the U.S. will impose a tariff of between 3% and as high as 24% on Canadian softwood products.

While this is softer than the rate of 40% (or more) that some were expecting, the impact has been felt…

On one hand, the SPDR S&P Homebuilders ETF (NYSE: XHB) and the iShares U.S. Home Construction ETF (NYSE: ITB) fell. That’s because the tariff will increase Canadian lumber costs to U.S. consumers by an estimated 6.4%. This means the average price of a U.S. single-family home will increase by $1,236.

On the other hand, most lumber companies – both U.S. and Canadian – shot higher. The iShares Global Timber & Forestry (Nasdaq: WOOD) and Guggenheim MSCI Global Timber ETF (NYSE: CUT) popped since the Commerce Department announcement.

Almost 47% of the Guggenheim MSCI Global Timber ETF’s holdings are American companies like Weyerhaeuser (NYSE: WY), International Paper (NYSE: IP) and Packaging Corp. of America (NYSE: PKG). These are the companies expected to be helped by the tariffs.

Lumber prices are expected to continue to move higher, at least in the short term.

Meanwhile, the rates imposed on Canadian companies vary. The average is 19.88%. But Resolute Forest, which ships 65% of its lumber to the U.S., will have to pay only a 12.82% rate – well below average.

West Fraser will be hit with a rate of 24.12%; Canfor’s will be 20.26%.

It’s no surprise that Canada has vowed to fight the tariffs. And there’s a long road ahead before they’re officially imposed. But as you can see, there are already clear winners and losers…

Canadian companies (like Resolute Forest) that were hit with lesser tariffs and American lumber suppliers are potential winners.

And American companies that rely on Canadian softwoods – for anything from homebuilding to flooring and beyond – will suffer from higher costs.

Commodity investors, take note. We’ll keep an eye on this trade war as it unfolds.

Good investing,

Matthew