Making the "Lead"
The writing substance in pencils is not actually lead, but a mixture of graphite and clay that is combined in water and molded into rods under extreme heat. This material is confused with lead because when graphite was originally discovered, the finders mistakenly thought they had found lead.
Cutting the Wood
Slats of wood are cut, and grooves half the size of the graphite rods are cut into the slats.
Inserting the Graphite
The graphite rods are placed into the grooves, and a second, equally grooved slat is glued on top to encompass the graphite rod.
The wood is then sanded down and painted with several coats to make the pencil appear to be a solid surface rather than two slats of wood glued together around a graphite shaft.