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Best Industry Sector for 2011: Agricultural Fertilizer

By Jim Fink on January 28, 2011

Energy is Canada’s most important natural resource. But as BHP Billiton’s aggressive takeover bid for Potash Corp of Saskatchewan demonstrated yet again, prolific oil and gas reserves are far from the country’s only bounty.

— Roger Conrad, Canadian Edge

Egypt is a tinderbox. Massive political demonstrations in the cities of Cairo, Suez, Ismailiya, Alexandria and elsewhere are scheduled today (Jan. 28th) after the noontime Friday prayer (jumu’ah), which ensures maximum participation by the male population. Common wisdom – including Nobel Prize winner Mohamed ElBaradei — says that the demonstrations are against the undemocratic rule of President Hosni Mubarak, who has governed Egypt with an iron fist under a “state of emergency” for the past 29 years. The same rationale was widely given to explain the popular uprising two weeks ago that successfully ousted Tunisia’s long-time dictator Ben Ali.  

Food More Important than Democracy

I have another theory: it’s mostly about food prices. As I wrote in What’s Wrong with India’s Stock Market?, food prices are skyrocketing throughout the developing world.  Government leaders attending the World Economic Forum in Davos Switzerland were quoted yesterday (Jan. 27th) saying that high food prices are one of the major causes of social unrest and could even spark the next war!

It’s not a coincidence that Ben Ali’s last concessionary offer before fleeing to Saudi Arabia was to cut the price of bread, milk and sugar. Nor is it chance that today’s Egyptian protests are occurring in the midst of food prices rising at a 17% annualized clip and the day after wheat prices hit a 29-month high. 

Emerging-market governments worldwide (e.g., Saudi Arabia, Algeria, Indonesia, Bangladesh) are engaged in panic buying of food to quell social unrest. Many of these governments are also instituting export restrictions on their domestically-produced foodstuffs, a practice that the United Nations warns will only make food price inflation worse.

QE2 and Global Warming are Wreaking Havoc in Emerging Markets

What is causing this emerging-market food inflation? Population growth, antiquated farming techniques, and bad weather all play a role, but I’ll add Ben Bernanke to the mix. This past Wednesday (Jan. 26th), the Federal Reserve Open Market Committee met and issued a statement that the planned purchase of $600 billion of longer-term Treasury securities (i.e., quantitative easing) by the end of the second quarter of 2011 will continue despite signs of accelerating economic growth. While printing hundreds of billions of dollars is a small risk for the U.S., which suffers from high unemployment and a housing bust, it’s a completely different story in the high-growth emerging markets.  For emerging markets, QE2 is like throwing gasoline on a fire.

With regard to weather, global warming is a real problem that appears to be getting worse. Investment legend Jeremy Grantham of GMO talks about global warming’s effect on the global food supply in his latest quarterly letter (free registration required):

The hottest days ever recorded were all over the place last year, with 2010 equaling 2005 as the warmest year globally on record. Russian heat and Pakistani floods, both records, were clearly related in the eyes of climatologists. Perhaps most remarkable, though, is what has been happening in Australia: after seven years of fierce drought, an area the size of Germany and France is several feet under water. This is so out of the range of experience that it has been described as “a flood of biblical proportions.”

More to the investment point: Russian heat affects wheat prices and Australian floods interfere with both mining and crops. Weather-induced disappointment in crop yield seems to be becoming commonplace.

With weather acting more like an enemy than a friend, the world’s crops need all the help they can get to grow.

Increasing Food Supply Via Fertilizer is the Only Solution

There are only two ways to bring down food prices: reduce demand or increase supply. Since the world population keeps growing and humans need food to live, I don’t think reduced demand is in the cards. That leaves increasing supply as the only alternative, and the best way to increase supply is by using agricultural fertilizer — potash to be exact. As I wrote in BHP Will Increase its Takeover Bid for Potash Corp.:

Potash fertilizer, which helps crops grow in dry soil by strengthening roots and boosting crops’ ability to withstand disease, is absolutely essential for farmers in increasingly water-starved areas.

There is no substitute for the potassium in potash; crops need potassium to live, period. Although potash is not a rare earth metal, supply is limited for two main reasons. First, it is very expensive to construct a new potash mine in any of the 12 countries where it is produced; Engineering group Amec estimates the cost at $4 billion. Such a high cost acts as a significant barrier to entry by new competitors.

Potash is Controlled By Two Cartels

Second, the existing potash supply is controlled by two cartels, the Canada-based Canpotex cartel — composed of Potash Corp. of Saskatchewan (NYSE: POT), Mosaic (NYSE: MOS) and Agrium (NYSE: AGU) — and a Eastern Europe cartel composed of two Belarus companies (Belarussian Potash and Belaruskali) and two Russian companies (Uralkali and Silvinit, which plan to merge in May). Combined, the two cartels control 80% of all the potash sold in the world. Now that’s what I call market power! As one Russian analyst recently put it, the merger of Uralkali and Silvinit will help all potash producers:

A merger would increase the power of the combined company as it could ask clients for higher prices. Potash Corp could also ask for higher prices. This consolidation will affect the industry on a global level.

Potash Prices are Primed to Go Much Higher

Potash prices have been relatively stable for the past few years, being kept in check by the global recession. But developed economies are recovering and emerging market economies are once again going full-steam ahead. The cartels just recently moved from annual contracts to six-month contracts, so these companies will be able to benefit from increases in the spot price of Potash faster than they have in the past. While the spot price for potash is currently around $430 per metric ton, the cartels offered China a six-month deal at $400.

Analysts expect the price offered to China for the second half of 2011 to be around $500. And don’t forget that this is a negotiated, volume-discounted price. Since the record-high spot price for potash was $1,000 per metric ton in 2008, spot prices could go much higher than the negotiated price.

At the end of last year, Pavel Grachev, CEO of Uralkali, said that potash prices “look great” for 2011. According to Grachev:

Definitely I see price strength next year. There is no possibility of prices going lower or even staying the same.

More recently this week, Potash Corp. CEO Bill Doyle made the following statement during his company’s earnings conference call yesterday:

We believe we are moving into one of the most positive environments for agriculture that we have seen in our company’s history. Spot prices are going to move pretty quick here. I think in the second half of the year, you’ll see an increase in North American prices because I think you’re going to see a substantial move in spot market. This market is going to be a supply constraint. When you get in a supply constrained market, you’re going to see prices move up more rapidly.

Potash Corp.’s Financial Results are Fantastic

To think the potash market is going to get even stronger in the second half of the year is rather mindboggling given how well Potash Corp – the largest potash producer in the world — is doing right now. The company’s fourth-quarter financial report was a barn-burner, with Q4 earnings per share more than doubling and full-year profits the second-highest in company history. Furthermore, the company announced that it was raising its dividend by a whopping 110% and is splitting its shares 3-for-1.  The stock has jumped 6.9% over the past two days on these announcements and now trades at $174.14, 34% above BHP’s $130 takeout offer last autumn. Potash Corp. shareholders must be thanking their lucky starts that the company rejected BHP’s “grossly inadequate” offer and the Canadian government ruled against the takeover because it would not provide a “net benefit” to Canadians. 

How to Invest in Fertilizer

None of the Belarus or Russian potash companies trade on U.S. or Canadian stock exchanges and, even if they did, I probably wouldn’t be interested. As I wrote in Russian Oil Company Lukoil is Cheap for a Reason, investing in Russia is a crap shoot because private property rights are not respected. Consequently, an investor’s best option for participating in the fertilizer craze is to buy one or more of the Canpotex cartel companies (POT, MOS, AGU) or a non-cartel independent like Intrepid Potash (NYSE: IPI). Agricultural biotech company Monsanto (NYSE: MON) also makes sense, as does the Canadian agricultural stock Roger Conrad likes best (see below).

Find the Best High-Yield Canadian Stocks With the Help of Canadian Edge

According to Roger, editor of the market-beating Canadian Edge newsletter, Potash Corp. has run up so much that it may not be the best way to capitalize on the fertilizer boom. He likes another agricultural stock better because it pays a higher dividend and has more appreciation potential. In fact, he likes this “ag” stock so much that he recommends it in his Canadian Edge “Aggressive Portfolio.”

To find out the name of this agricultural powerhouse stock that also pays a 4.8% annual dividend, give Canadian Edge a try today!

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