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Potash Article - Whiskey & Gunpowder

[loonie4bucks]

I don't think this writer is aware of Allana and it's potential, but definately an interesting read.

Gary’s Note:Oil isn’t the only commodity that will be going way up. If you thinkoil has potential to make smart investors wealthy, just wait till youread what Chris Mayer has to say about agricultural commodities. Chrisalso has a couple of plays in this field that are bound to make hissubscribers very wealthy. Read on to find out more and how to get in onthe play.

Whiskey & Gunpowder
By Chris Mayer
May26, 2010
Gaithersburg, Maryland, U.S.A.

The GravestResource Shortage
You’ve Never Heard Of

There are factors building up pressure under theprice of other commodities. Demand for food is growing and set toexplode. Smart investors will be properly positioned to take advantagewhen agricultural commodity prices skyrocket.

Nearly a thirdof the planet’s population is growing richer in the east. One of thefirst things people change as they emerge from poverty is their diet.They move toward more meat and a greater variety of fruits andvegetables. So while we may wonder about how many cars or toasters thebrave new world’s top consumers will want, we know for sure they’ll eatmore food.

But the web of food production shivers and shakes inthe short term in response to economic pressures. Farmers cut back —like everybody else — in 2008 and 2009. One of the things they cut backon was fertilizer. They used 30–40% less potash than usual, forinstance. Potash, a key fertilizer ingredient, saw six consecutivequarters of falling volumes.

Farmers ran down their inventories.All that deferred buying pushed North American potash inventories belowtheir five-year averages — first time that’s happened since November2008. In some cases, farmers didn’t apply potash at all. Potash stays inthe soil for up to two years, so you can skip applications. But you cando that for only so long.

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Inany event, farmers are now returning to the market. One potash companyreported its highest potash volumes ever in the first quarter of 2010 — afivefold increase, year over year. With corn at around $4, famers haveevery incentive to buy fertilizers. Grain prices support good returnsfor farmers at current fertilizer prices.

Longer term, there willbe pressure to produce more food. In turn, farmers will seek to boostcrop yields. Fertilizers are one way to get there. There is plenty ofroom for growth here, as application rates remain well below recommendedrates.

Of all the nutrients, potash has thegreatest potential for growth — a potential 298% increase tomatch that recommended rate of 66 pounds per acre.

Oneinteresting piece of news from China in February was the governmentinitiative to boost crop yields by sending out 100,000 agronomists toeducate 160 million farmers about modern farming techniques. The goal isto boost fertilizer use and demonstrate the benefits by way of soilsamples. China is the biggest fertilizer market in the world, butcrucially, it lacks much in the way of potash. China must import most ofits growing needs.

That’s because potash is a rock and qualitymines are scarce. It costs a lot of money and time to bring one online. Abrand-new (or greenfield) 2 million-tonne potash mine will cost you aminimum of $2.2 billion — not including what it would cost forinfrastructure such as rail, power, etc. It would also take seven years.

Sothe bigger-picture reasons for owning potash still make sense.More importantly, for our purposes, is the value of the stocks.

TheApril 20 edition of Foreign Policy included a story titled“Peak Phosphorous,” with the subhead: “It’s an essential, ifunderappreciated component of our daily lives, and a key link in theglobal food chain. And it’s running out.”

The story begins:

“From Kansas toChina’s Sichuan province, farmers treat their fields withphosphorus-rich fertilizer to increase the yield of their crops… Ourdwindling supply of phosphorus, a primary component underlying thegrowth of global agricultural production, threatens to disrupt foodsecurity across the planet during the coming century. This is thegravest natural resource shortage you’ve never heard of.”

You think OPEC is a force with 75% of theworld’s oil reserves? Well, just five countries control 90% of theworld’s phosphate reserves: Morocco, China, South Africa, Jordan and theUnited States.

The U.S. has only 12 phosphate mines.When food supply issues get hairy, countries essentially stop exportingphosphate. China did this in 2008. (China has the second largestreserves of phosphate, after Morocco.) I don’t see a phosphate shortageas imminent, but it’s a potential flash point that would surely light afire under a couple of the stocks in the Capital & Crisisportfolio.

These stocks are potential monsters. They could doubletheir output by 2015 and 2020. About 75% of new supply coming onlinetill 2020 is from these two titans. This provides a powerful way toincrease earnings even if potash prices go nowhere. If prices do climb,then earnings will jump sharply.

The value in these stocks,though, really comes from their huge net asset values (NAVs), as seen bylooking at replacement values. In other words, let’s answer thequestion what would it cost us to build these assets from scratch?

Ifit is cheaper to buy the stocks than to build the assets, we have apromising situation. Think about that as if you were potash producer. Ifit cost you $1 billion to build a 1-million-tonne facility or $500million to buy a ready-made potash mine in the stock market, what wouldyou do?

All things being equal, you buy the stocks. Intoday’s market, the stocks are cheaper than building new mines.A number of global mining giants get the attractive investment profileI’ve laid out for you. Vale and BHP have already made small purchases.Vale bought Bunge’s phosphate mines and took a majority stake inFosfertil, a Brazilian fertilizer company. In 2009, Vale also boughtpotash reserves in Argentina and Saskatchewan. BHP already owns reservesfor a possible mine in Saskatchewan. All of these would be greenfieldprojects.

So given all the risks, expense and time… why not justbuy the two big players in the Capital & Crisis portfolio if theyare cheaper? (Not only are they cheaper, but the assets are of amuch-higher quality).

I have my own conservative estimates oftheir NAVs based on replacement value. However, I could be wayconservative. Morgan Stanley’s estimates are much higher, to give oneother estimate. They include an estimate for infrastructure. They alsouse average costs based on existing publicly disclosed greenfieldprojects.

The high cost of new assets also provides price supportfor fertilizer prices. To lay out all of that cash for a new potashmine and get just a 10% return on your investment, you’d need potashprices of $500 per ton to make it work. Currently, prices are around$350 per ton. Brownfield expansions — or additions to existing mines —are cheaper. Some can work at prices as low as $250 per ton. Thesebrownfield expansions are what the Capital & Crisisinvestments are doing. But they’ve got the best assets.

Regards,
ChrisMayer

P.S.: All in all, I think the case forthese stocks is still a good one. Earnings are highly uncertain, but theasset values are there. And we’ve got good catalysts going forward. Themarket is focused on the near-term record harvest, but I look to thelong-term value in these stocks, especially as Great Depression 2.0kicks into higher gear. If you haven’t already subscribed to my Capital& Crisis newsletter, now is the perfect time to start