Why commodity investors better watch their potash
Keith Woolhouse
The Ottawa Citizen
Thursday, May 01, 2008
The problem with bubbles is that they're great while they last, and those soapy ones are pretty to look at, but there's always the unease of not knowing when they're going to burst. Think back to the craziness that swept through the high-tech sector, much of it promoted not just by the companies, but also by their employees, who were so deluded they bought into their own hype.
That's similar to what's happening now on the commodities front, where skyrocketing prices have analysts talking of "atmospheric price levels" to come, as if they aren't high enough already.
Commodity prices have been on a tear the past few weeks. In late-March, the Commodity Research Bureau's price index, the global benchmark, was at 382 points. Today, it's close to 420 points, after staging a spectacular rally in which nearly every component participated.
That mystifies Scotia Capital equity strategist Vincent Delisle. "One puzzling aspect of this commodity surge is the fact that it is occurring in synch with near confirmation that the U.S. economy is in recession, faltering confidence in the European Union, and warning shots from the International Monetary Fund, the U.S. Federal Reserve Board and the G7," he said.
Confidence among American consumers is at a five-year low having slid 41 per cent in the past year, one of its steepest declines ever. The U.S. Federal Reserve Board's summary of regional economic conditions, which depicts a slowing economy with softening consumer spending, weakening labour markets, rising input costs and tightening credit conditions, supported that.
"The main driving forces behind the commodity surge are resilient demand and the lack of any supply response," said Delisle. "And since the dominant commodity-consuming countries do not appear to be as price sensitive as Wal-Mart shoppers, the sweet ride is bound to continue to surprise. However, one could only imagine what would happen should the laws of supply and demand eventually work their way back into the equation."
Delisle is not the only skeptic out there. Agricultural prices have rocketed. Wheat has soared 157 per cent this year, canola is up 86 per cent and barley 42 per cent. Coal has climbed 125 per cent, oil 70 per cent, gold 40 per cent, silver 31 per cent and natural gas 23 per cent.
Apart from the price of oil, one of the biggest talking points has been potash and its perpendicular rise. Potash Corp. of Saskatchewan (POT/T) has soared 234 per cent from a 52-week low of $65.46 to a high of $218.50. It's around $185 today, and earlier this week it assumed the mantle of Canada's largest company with a market capitalization of $67 billion.
Potash Corp. recently sold to China for $576 U.S. a tonne, 227 per cent more than the existing price. That pales into insignificance with the announcement out of Belarus that the Belarusian Potash Company has upped the price in Asian and Latin American spot markets, effective July 1, to $1,000 U.S. a tonne.
Vladislav Baumgertner, president of Uralkali, the national producer, said the "continuous growth of global demand, historically low inventory levels and unprecedented tightening of the supply" justified the price.
That reasoning had Merrill Lynch chief strategist David Wolf shaking his head. "The lofty levels of fertilizer stock prices appear to be premised on the indefinite sustainability of recently higher potash prices. We're not industry specialists, but we think the following four observations are important," he said.
"First, there's plenty of potash -- nearly 300 years of known reserves at current consumption rates, according to the International Fertilizer Association.
"Second, you could hardly have found a worse investment in modern times -- according to the U.S. Geological Survey, real potash prices have fallen 95 per cent from their record (peace-time) peak in 1919 through the recent trough in 2003.
"Third, the current combined market cap of the three large North American producers -- Potash Corp., Agrium Inc. (AGU/T) and Mosaic Co. (MOS/NYSE) -- is bigger than the value of all of the potash ever sold in the history of the world.
"Fourth, and in our view most importantly, we believe that the euphoria in the fertilizer sector reflects a potentially dangerous broader trend across the commodity spectrum -- investors mapping evident short-term supply/demand imbalances into expectations of persistent long-term supply/demand imbalances."
Nevertheless, analysts in their 12-month outlooks remain hot for potash, and particularly Potash Corp., but there are signs the bubble, if not burst, may be pierced.
RBC Capital Markets on Tuesday downgraded the world's largest crop nutrient maker to "outperform" from "top pick," but maintained the 12-month target price at $300 U.S. Elsewhere, TD Newcrest maintains its "buy" recommendation and a target of $280 U.S., Credit Suisse First Boston is "neutral" with a $210 target, and BMO Nesbitt Burns rates it "outperform" with a $200 U.S. target.
If you're still intent on jumping on the fertilizer bandwagon, Dundee Capital Markets analyst Richard Kelertas recommends two Chinese speciality potash producers trading on the S&P/TSX.
Hanfeng Evergreen Inc. (HF/T) and Migao Corp. (MGO/T) deliver to their domestic markets where demand for potash is massive.
Kelertas rates both a "buy" with Hanfeng his "top pick" and a 12-month target of $17. Migao's target is $10.25.
Kelertas reckons the two Chinese firms are "significantly undervalued" and have an implied value of between $42 and $44. Hanfeng is currently around $12 and Migao is at $7.70.
© The Ottawa Citizen 2008 |
