Juniors Poised to Rise
January 10, 2011
Matthew B. Smith
The potash industry has rebounded nicely since our article
on January 4, 2010 where we called the bottom in contract prices for potash
(see here). Two
junior exploration firms in Saskatchewan have been taken over, or announced
agreements to be taken over in the case of Potash One, while the others have
seen significant price appreciation on the heels of BHP buying Athabasca Potash
and then submitting a failed bid for Potash Corporation of Saskatchewan. It is
our belief that these healthy gains we have seen in the price of potash are
simply the beginning of another powerful bull move upwards, rather than another
top as the bears would have you believe.
All investors need to look at what is fact, and what is
highly probable down the road. This allows for one to better understand how
markets may act and where various industries will stand down the road.
Everyone knows of the tight supplies existing in the grains market over the
past 6 months due to various weather conditions around the world, which we
believe may create a new fundamental shift among the world’s leaders. Most of
the world’s food comes from a few regions around the world, most notably the
United States, Canada, Russia (and its former satellites), Australia, Europe,
Brazil and Argentina. In the past six months alone we have seen natural causes
destroy or badly damage crops in Canada, Russia (and the former satellites) and,
with the recent floods, Australia too.
This will badly hurt exports for Australia, and Russia has become a net importer of grains for the next year due to their drought. This
means less for exports, thus higher costs for the world’s net importers of
these various grains.
Due to these events, and the resulting prices, it is our
opinion that many of the world’s net importers of grains will look to diversify
their suppliers going forward. By this we do not mean they will look to get
half of their needs from Russian and the other half from the USA rather than
their current 100% from Russia. Our guess is that we will see countries like
China, India, South Korea and others begin to establish strategic initiatives
to grow their own needs (both for their own consumption as well as the needs of
their growing manufacturing sectors). The world’s best farmland is already
farmed, in fact in the Midwestern United States some of it has actually been
developed for housing and other uses, so some is wasted but other counties will
begin to develop farmland which is arguably not ideal. Maybe not enough
rainfall in the region or lack of infrastructure, however we are more concerned
with the fact that less ideal soil types will require far more fertilizers in
order to produce desired yields.
It is our belief that the winds are still at our backs when
it comes to the potash market, and we only have to look as far as BHP to fully
understand this. BHP is one of the world’s preeminent resource investors,
moving into various resource classes at just the right time, in the past it has
been uranium, copper and gold, but we think their surprise bid for Potash Corp.
of Saskatchewan was a watershed moment. BHP had two big potash projects being
developed in the region at that time and would be in production in a few years’
time, however they knew prices were going to move higher soon, much earlier
than they would be in production, and they wanted to be in the industry in a
Uber-Bullish as the Germans would say. Or rather the
management at K+S, who wanted in to the industry but saw that buying a current
producer was out of the question, so they gobbled up the best junior still out
there at the time, Potash One.
Simply put, our call is that potash juniors are undervalued,
potentially grossly so. More players want into the industry, and current
players in the industry are consolidating, which has effectively put more
production and pricing power in the hands of a few for the time being. Looking
forward, we see tremendous upside in the junior potash players and in the next
few months will profile some of the best plays we see out there.
We have remained bullish of our potash thesis set up a few
years ago, and believe that the correction that took place in the market was
due to the financial fiasco the world found itself in rather than supply and
demand being imbalanced. Potash Corp. of Saskatchewan, Mosaic and Agrium will
continue to dominate the potash market along with their counterparts who are
teaming up in Russia. Until BHP opens up their new mines, one currently in
development and the other likely to start development in the near future, we
believe that this oligopoly will deliver increased prices to those companies
involved along with record profits.