The holiday season is one of my favourite times of the year. Taking a break from the hectic pace of day-to-day life is something to be treasured, especially with family and friends. Unfortunately, the holiday season can also take a toll on your wallet. This year, you may have noticed a spike in the cost of your Christmas tree. According to The National Christmas Tree Association, trees are 10% higher in price this year and the selection of trees may be very limited in some areas. What’s causing these increases? It could boil down to basic supply and demand economics:
- Families are becoming more traditionalist and are forgoing ‘fake’ trees for real ones (increased demand for real trees)
- There are less trees available this year than usual (decreased supply of real trees)
This holiday season, the primary reason is the latter and the explanation is fascinating. It takes about nine years to grow a Christmas tree to maturity. This means the current shortage is a direct result of low demand (and I assume low prices) for trees back in the heart of the financial crisis of late 2008. That low demand led producers of Christmas trees to plant fewer new trees because, for a whole host of reasons, it was difficult to reinvest in the future when the present looked so bleak. The high prices and significant shortages we see today are a result of this underinvesting.*
This is a classic microcosm of the commodity cycle, applicable to almost any commodity and important to value investors like Burgundy. Let’s take oil and natural gas: Could the low prices of oil and gas in 2016 and 2017 lead to underinvestment in developing new supply and create a shortage and higher prices in the future? We think so. While more complex, the basic economics align with the current situation with Christmas trees. We know that reinvestment in developing new supply in the oil and gas industry is significantly down from its peak prior to the financial crisis. Our objective as long-term (and often contrarian) value investors is to buy when prices are low on the expectation that they will rise over the long run. One day, we expect the market to wake up to the realization that there has been significant underinvestment in new supplies of oil and gas and prices will rise.
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I should mention that this same phenomenon also happens in reverse. There is an old saying in the commodity business that ‘the cure for high prices is high prices’. The high prices and profits experienced with Christmas trees today will likely lead to overinvestment in future supply and eventually lower prices. Today’s record price will lead to a glut in nine years. I just might plan on getting two in 2026!
For further (and more serious) reading on the commodity cycle, refer to the following:
Article by Mathew Harrison, Burgundy Blog