One of the first things people change as they emerge from poverty is their diet. They move toward more meat and a greater variety of fruits and vegetables. So while we may wonder about how many cars or toasters the brave new world’s top consumers will want, we know for sure they’ll eat more food.

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

Farmers ran down their inventories. All that deferred buying pushed North American potash inventories below their five-year averages — first time that’s happened since November 2008. In some cases, farmers didn’t apply potash at all. Potash stays in the soil for up to two years, so you can skip applications. But you can do that for only so long.

In any event, farmers are now returning to the market. One potash company reported its highest potash volumes ever in the first quarter of 2010 — a fivefold increase, year over year. With corn at around $4, famers have every incentive to buy fertilizers. Grain prices support good returns for farmers at current fertilizer prices.

Longer term, there will be pressure to produce more food. In turn, farmers will seek to boost crop yields. Fertilizers are one way to get there. There is plenty of room for growth here, as application rates remain well below recommended rates.

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

One interesting piece of news from China in February was the government initiative to boost crop yields by sending out 100,000 agronomists to educate 160 million farmers about modern farming techniques. The goal is to boost fertilizer use and demonstrate the benefits by way of soil samples. China is the biggest fertilizer market in the world, but crucially, it lacks much in the way of potash. China must import most of its growing needs.

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

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

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

The story begins:

“From Kansas to China’s Sichuan province, farmers treat their fields with phosphorus-rich fertilizer to increase the yield of their crops… Our dwindling supply of phosphorus, a primary component underlying the growth of global agricultural production, threatens to disrupt food security across the planet during the coming century. This is the gravest natural resource shortage you’ve never heard of.”

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

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

These stocks are potential monsters. They could double their output by 2015 and 2020. About 75% of new supply coming online till 2020 is from these two titans. This provides a powerful way to increase 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 by looking at replacement values. In other words, let’s answer the question what would it cost us to build these assets from scratch?

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

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

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

I have my own conservative estimates of their NAVs based on replacement value. However, I could be way conservative. Morgan Stanley’s estimates are much higher, to give one other estimate. They include an estimate for infrastructure. They also use average costs based on existing publicly disclosed greenfield projects.

The high cost of new assets also provides price support for fertilizer prices. To lay out all of that cash for a new potash mine and get just a 10% return on your investment, you’d need potash prices 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. These brownfield expansions are what the Capital & Crisis investments are doing. But they’ve got the best assets.

Regards,
Chris Mayer
Whiskey & Gunpowder

May 26, 2010

Potash, China and the Fire Under Agricultural Commodity Prices was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Five years ago, almost no one believed that oil prices would soar past $30 per barrel. $50 seemed utterly unthinkable. As oil prices continued climbing, so did disbelief. The skeptics never abandoned their misguided notion that oil was “overpriced.” So when crude retreated from $75 to $50 early last year, the prospect of $100 oil seemed like a ridiculous prediction.

Due to Peak Oil, the prices of agricultural commodities are going much higher…

Most of the agricultural markets have had a big move already, but these markets could easily suffer a big correction from current levels. The long-term investor will want to buy these markets on weakness, not sell them.

A hundred years ago, the average American spent about 45% of annual income on food. Today, that figure is down to about 15%. So we’ve been taking cheap food for granted and have spent our “extra” cash on plasma TVs and leased BMWs.

We don’t worry about food costs or whether it will be readily available tomorrow. But the agricultural markets may have some major surprises in store for complacent Americans…and unprepared investors:

While shortages of key industrial and energy commodities are frightening, no sector will threaten global stability more than agriculture…

In 2007, we saw stark glimpses of just how bad this situation will get. The “Tortilla Crisis” in Mexico, the “Pasta Protest” in Italy, the riots and crushing of one supermarket shopper in China over cooking oil… We have seen dairy, meat, and bread prices skyrocket.

It’s ironic that as global population is reaching an all-time high, we are turning a huge percentage of our crops into ethanol or biofuel…

This questionable, if not idiotic, alternative produces little, if any, short-term benefit and considerable long-term harm — both to the quality of farmland and to the integrity and stability of the global agriculture markets. In other words, using food as fuel can make a big mess out of the global food supply…and the prices that we all pay for that supply.

From sea to shining sea, the U.S. has croplands as far as the eye can see. For years, its bounty has been a supermarket for the world. Now it’s a fuel station, too.

China, which has hundreds of millions more hungry mouths than we have, has far less arable farmland. And worse, China has far fewer controls in place to regulate farming methods.

Trends like these strongly suggest that the agricultural markets will imitate the price action of the energy markets. As investors, we must look at this situation as an opportunity…

We should be looking to buy stocks of some of the key agricultural companies that help support the industry: those dealing with equipment makers, fertilizer, irrigation, and transport.

In my own portfolios, I have exposure to soybeans, wheat, and corn. I also think the soft commodities are much undervalued: coffee, cocoa, sugar, and cotton. These markets are also poised to move much higher…

The planet is not running out of food, but it might be running out of cheap food. So stock up your pantry and start shopping for the kinds of investments that will prosper during the coming agriculture boom.

Regards,
Kevin Kerr
June 23, 2008

P.S.: So now you know what to expect. Food prices will be higher, and there’s not much that you can do about it. So how are you planning to pay for all this expensive food? If you’ve been trying to make your money by just playing the stock market, chances are you haven’t had too much success. But luckily, there’s another market that is paying much more than just regular stocks. And many investors are finding it easier than ever to put food on their tables and still have money left over.

Agricultural Shortages was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The first thing I saw when I walked onto the floor of the exchange was that the price of one bushel of spring wheat had closed up 89 cents (limits were 90 cents for spring wheat, other than the March contract) in overnight electronic trading. I was looking at $20 wheat for the first time in our history, but it was only just getting started.

Before I continue on, I need to make one thing clear. The March wheat option expired last Friday. An option is simply the underlying right, but not the obligation, to buy a futures contract. At this point, bakers, pizza makers, and other people looking to actually buy wheat via the futures market will begin to hold more and more contracts, while the traders will have less and less of a position. More importantly, this means that the March futures contract will no longer have a limit. This means that the price of wheat for March delivery can trade as high or low as it needs in order to represent a true supply-and-demand scenario.

Once the opening bell sounded, March wheat traded strong to the upside, but this was to be expected. Before long, the pit was a frenzy. All of a sudden, I heard traders yelling, “21 bid, 22 bid, 23 bid,” meaning that the traders were trying to buy wheat at $20 per bushel. In order for a transaction to take place, another trader must be willing to sell at whatever price someone is bidding.

I was second-guessing my own ears. Wheat was ticking up, or being bid up, by the DOLLAR! Now, each futures contract represents 5,000 bushels of wheat. So a $1 move in the price of wheat equates to a $5,000 move per contract.

Before this crazy bull market started, wheat ticked by quarter cents and pennies, with the occasional two-cent tick. These past few weeks had been marked by nickel and dime ticks, which would have seemed ridiculous six months ago. But in the rest of Monday’s trading, wheat was ticking by quarters, 50 cents, and dollars at a time…absolutely remarkable.

The market peaked at $25 per bushel, or a $5.75 rise in price from Friday’s close. We closed at $24 per bushel, a 25% single-day gain, marking the single biggest daily move in any agricultural market in the history of agricultural markets. If you were long, or had bought, 10 contracts at Friday’s close, you could have bought a nice house on the money you would have made in one day of trading. This chart of the March futures contract says it all:

How does a nearly 500% gain in 10 months sound? “Parabolic” is truly an understatement. As consumers, we haven’t seen the true effects of the rise in price, but believe me…we will.

But that’s not even the whole of it. May spring wheat was already $20 bid at $20.20 ask via synthetic trading in the options pit. Let’s say wheat closed last Friday at $18.10 per bushel. The limit is 90 cents. That means that once wheat is $19 per bushel, it can’t go any higher, but options don’t have limits. This means that the futures traders can use options to make bets beyond the limits.

Now, the rest of the 2008 and some of the 2009 contracts locked limit up at 90 cents in Minneapolis. Chicago and Kansas City wheat was locked limit up across the board (all futures contracts were locked limit up)! Chicago oats were locked limit up across the board. Soybeans were up 35 cents, to 40 cents, across the board. Soy oil and meal had huge days. Corn was up 15-20 cents per bushel across the board. All of those ag commodities, minus corn, hit record highs.

Dear readers, this past Monday marked the single most historic trading day in the agricultural commodities, and you can bet your last dollar that this thing is far from over. For years and years, the whole notion of agricultural commodities has been looked over when it comes to your average investor (or commodities investor, for that matter). It just isn’t as sexy as, say, oil, gold, or uranium, but now having exposure to the agricultural markets has become a MUST in every portfolio.

Regards,
Nick Jones
March 6, 2008

A Bull Market for Wheat was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.