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.

The story line in both Earth Stood Still movies is pretty straightforward. An alien spaceship comes to Earth and lands in Washington, D.C. in the 1951 movie, and in New York’s Central Park in the current remake. Out pops an alien with a “Take me to your leader” gleam in his eye. But in both movies, some trigger-happy soldier shoots the alien. (Although in the current remake, it could have been accidental — like what happened with New York Giants football player Plaxico Burress.)

After the alien gets shot, a giant robot appears from the spaceship and begins firing death rays at the assembled human greeters. But the wounded alien calls off the robot. Then the alien goes to a hospital, where earthling doctors try to figure out how to patch him up. Turns out that the alien looks a lot like the movie actor Keanu Reeves. 

Later, the authorities come in and ask the alien what he wants. “Why did you come to our planet?” they inquire, with a false sense of innocence dripping from their collective lips.

“Your planet?” replies the alien.  Uh oh.  It’s worse than we thought.  The aliens are mad at us.  And it doesn’t help that we shot the guy.  So it’s time to call Houston and tell them that we have a problem.

Death Ray Gap

Of course, the authorities fear the alien because they know that his death rays are better than our death rays. In true Cold War fashion, we have a “death ray gap” that leads to a chasm of misunderstanding.  That, and the unnerving sense of territoriality that the alien seems to exhibit towards our blue orb.

The bottom line is that the alien is visiting Earth to tell mankind to clean up its act, literally and figuratively. In the 1951 movie, the alien wanted to tell mankind not to kill itself off with nuclear warfare. It was an early sop to the anti-nuke movement. In the new release, it’s an environmentalist sequel to Al Gore’s movie An Inconvenient Truth. That is, the alien declares, “I’m here to save the planet.” 

No kidding. Justice is coming from outer space.  The aliens are going to save the planet, and save it good and hard. This particular alien and his kind are ready to out-do even the Earth First! crowd.  Tree-spiking?  That’s for sissies.  Burning down a Hummer dealership?  They’ll see that, and raise us by a few orders of magnitude.

“If the earth dies, you die,” says the alien.  “If you die, the earth survives.”  Whoops.  This cannot be good.

On cue, the giant robot — GORT, for genetically organized robotic technology — decomposes into a locust-like blizzard of nanoparticles. These tiny particles take flight like a dark cloud and start devouring all man-made substances (including people) in their path, breaking them down into the constituent elements.

There are some serious special effects involved. How serious?  Let’s just say that the New York Giants will need a new stadium in which to play.  And Donald Trump will have some new development opportunities in lower Manhattan — if there is anyone still around who wants to live there.  Yep, these aliens are going to save the planet by killing off mankind and leaving behind wide swaths of mineral sands. It’s urban renewal on nanotechnology steroids.

Girl Meets Alien

But there’s this good-looking female astrobiologist from Princeton. It’s the ageless and eye-popping pretty Jennifer Connelly who won an academy Award for her 2001 efforts as a Princetonian in A Beautiful Mind.  She also appeared in the 2003 movie version of The Incredible Hulk.  So I guess she’s into both smart and genetically altered guys.

It seems that astrobiology-girl took a bunch of government grant money for her research. Apparently, she never read the fine print. There’s a clause in the government contract that says, “If aliens show up, we draft you into the service of the nation.”

So our Princeton Tiger gets shanghaied off to help the government people deal with the alien. She shares a tender moment with the alien when he is in the hospital. And guess what? The alien guy kind of likes her, which is not hard to do when someone as hot as Ms. Connelly is holding your hand.

So to make a long story short, there’s this series of exciting chase scenes. Cars careen and crash. Helicopters hover and hit in fiery collisions. Kindred souls bond. Eventually, the Princeton lady uses her feminine charms to convince the alien to call off the nanobugs.

You go, girl.  Another Academy Award for Ms. Connelly?  She’s good but I don’t think she needs to overspend her budget for the gown she’ll wear to the Kodak Theater.  Even though, to Ms. Connelly’s great credit, the Earth is saved while mankind has to promise the aliens that we’ll stop wrecking the environment.

Stop wrecking the environment? What does that mean? Will the aliens be satisfied now that Carol Browner is going to make energy and environmental policy at the Obama White House?  Or do the aliens want something more than that?  Is there something more than that?  Really, even science fiction has its limits and Carol Browner may well be the one to take it to the edge of physics.

Well, for our purposes it means that the movie is over. That’s all you get for the $9.50 ticket.

After all the action and flying nanobugs, The Day the Earth Stood Still (v. 2.0) does not get to the part about how 6.5 billion people can continue to exist on this planet without using an industrial level of energy supply and industrial levels of agriculture, minerals, water supply, public health and much more. I guess that’s in the next remake, in another 57 years if we’re lucky.

Until we meet again,
Byron W. King

December 23, 2008

An Alien Tree-Hugger Scoffs At Earth’s Governments was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

In the future there will still be profound restraints on the availability of energy and natural resources. So owning shares in firms that “do energy” or “do resources” is still a good idea over the medium and long term.

We Still Have a Big Problem

We still have a big problem. The credit system is broken (and that’s the nicest thing you can say about it). Many large banks in the world are broken too (ditto). The investment model of the modern era, starting back in the 1860s during the U.S. Civil War, has almost ground to a halt. That is, the idea and method of “floating capital” is not functioning. Indeed, capital no longer seems to float. Actually, it seems like capital has been sinking like a stone. 

The lack of capital (at least, in the forms that we’ve come to utilize it for large scale investments) means that it is difficult – impossible in some cases – to go forward with the new energy and resource projects that are designed to mitigate the present depletions in older oil fields and other resource provinces.

In the face of this, most governments of the world are trying just to look good for the TV cameras. Central banks and government treasuries across the world have been reduced simply to throwing money at whatever problems catch their collective eye. Squeaky wheels get the grease. So we see the national treasuries “recapitalizing” busted banks. We see the likes of the U.S. Big Three automakers coming hat-in-hand to Congress for a bailout, and Congress in turn acting like it knows how to run a sophisticated manufacturing business. And we hear announcements, from China to the U.S., of massive new public works programs to get the world moving again. 

It’s like if we pour enough concrete, and then everything will turn out all right. Somebody ought to ask the Japanese about that. They all but paved the island of Honshu in the 1990s, and still lived through a stagnating era.

Can things really turn out all right? Can we return to some happy past? As Heraclitus once noted, “You cannot step twice into the same river, for other waters are continually flowing on.”  

Prosperity Stolen from Fort Knox

Indeed, all rivers flow to the sea. In Asia Times Online, the always insightful Henry C. K. Liu recently wrote that the credit crash has “turned out to be a catastrophic, global, financial perfect storm of unprecedented dimension that will cause serious structural damage to all market economies around the world. It may even spell the end of the cowboy finance capitalism of the past two decades in which risks are socialized and gains privatized, with debt manipulated to act as phantom capital.” Yep.

A fellow Pittsburgher, financial writer Jim Willie, is even more pessimistic. He thinks that in 2008 the U.S. economy and financial structure suffered “mortal wounds.” Jim states – using a very clever turn of phrase (I wish I’d said this) — that a “decade of prosperity was stolen from Fort Knox.” That is, major elements of U.S. monetary policy in recent years involved the gold carry trade enacted by the U.S. Treasury in the 1990s. 

What is the gold carry trade? The U.S. Treasury and Federal Reserve treat the details like state secrets. But what has leaked out makes for a sordid story – treasonous, even. It’s enough to make you wish that we still executed people by firing squad in this country. Let me put it this way. Perhaps President-Elect Barack Obama thinks that his biggest surprise will come when he gets “THE briefing” and finally learns what is really out in the tightly guarded hangars near Groom Dry Lake in Nevada (a/k/a “Area 51”), and Dugway Proving Ground in Utah. Well just wait until Pres. Obama asks how much of the original Fort Knox gold still remains the unencumbered property of the U.S. government. Surprise, surprise.

The Wolf is At the Door – Say Hello to the Nice Wolf

In 2008 we all experienced the destruction of a world-wide credit bubble. This was the end of many decades of dollar-abuse and monetary malpractice by the U.S. Federal Reserve and the utterly profligate U.S. government in general. As Gresham’s Law states, “Bad money drives out the good.” And decades of bad money did not just drive out the good stuff. In turn it sowed the seeds of its own destruction. 

It was just a question of time before the wolf showed up at the door, and that time has arrived. Say hello to the nice wolf. So now it’s time to face the fact that the U.S. economy is in far worse shape than most people believe. And it will be in bad shape for a long time to come. If everything goes right, it might take a generation to clean out the stables.

But we are already off to a bad start. The 2008 credit meltdown has caused huge collateral damage. And in 2009 we will see an extraordinary attempt to re-inflate that bubble. Will it work? Probably not like people expect. 

The traditional financial system is now in the fight of its existence. The system was based on U.S. dollar hegemony and the supremacy of U.S. national power. That, and the way that the U.S. benefitted from ingrained habits of foreign monetary authorities kowtowing to Washington based on decades of living with Bretton Woods and its ghosts. It all hit the wall in 2008. But like the creatures in the Aliens movies, these critters won’t stay dead for long. The Wall Street/Treasury Axis will come back to fight hard and play dirty. 

Things to Do to Ensure Your Security

I believe that the old system is irretrievably doomed. But you cannot replace something with nothing. There is still no “new” system that has come around to take the place of the old one. Thus the big task for 2009 is to save your personal wealth from going down with the ship. So how do you ensure your security?

In the short term you can protect your financial interests by increasing your cash position as a percentage of your assets. When all else fails, add to cash. Yes, we will probably see inflation in the future, but for now more cash is better. 

Also, in anticipation of inflation you should own physical metals like gold and silver. I mean it. I’ve said it before. OWN GOLD! And I mean OWN THE METAL. Take delivery! Maybe I sound like the Mogambo Guru on this, but he’s right. Let me quote Mogambo. “Own freaking gold!”

And get out of any but the very best shares. The first requirement for share ownership is to look for companies with enough cash to fund operations and make it through some very lean times. Then you also want to invest in firms that are going to be important in the world that’s coming down the tracks. 

What kinds of firms will be important? Well, energy and resource firms for starters.

That’s all for now. Thanks for reading.

Until we meet again,
Byron W. King

December 16, 2008

Falling Prices and Scarce Energy was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

How do you measure these things? In yields. This, by the way, is how you’ll know the bubble is popping. When that happens (bond yields rise like a rocket ship) it’s going to unleash financial chaos. But for now, the bubble just keeps on getting bigger and yields on short-term U.S. bonds keep approaching–and even reaching–zero.

“The Treasury sold $27 billion of three-month bills yesterday at a discount rate of 0.005 percent,” reports Bloomberg. It’s, “the lowest since it starting auctioning the securities in 1929. The U.S. also sold $30 billion of four-week bills today at zero percent for the first time since it began selling the debt in 2001.”

How do you think that conversation goes?

“Thirty billion you say? For four weeks? And you’ll pay me how much interest?”

“Nothing.”

“I’ll take it!”

“If you invested $1 million in three-month bills at today’s negative discount rate of 0.01 percent, for a price of 100.002556, at maturity you would receive the par value for a loss of $25.56,” reports Daniel Kruger.

Yes. That’s how much investors currently prefer government-backed bonds to equities at the moment. It implies there will be hardly any inflation at all over the next ten years. But that notion should make you spew milk through your nose as you laugh, unless you’re unfamiliar with the growth in the global monetary base. If so, let us remedy that.

You can see that in the U.S. alone the adjusted monetary base is…growing. So why isn’t the increase in the monetary base showing up in the kind of inflation that would terrify bond investors and lead to a rebound in commodity prices and equities? That’s another question we got last night.

The answer is that so far, the huge liquidity injections have been quarantined in the financial sector, mostly on bank balance sheets, or on deposits by banks at the Federal Reserve and other central banks. In other words, all the new money is going into bonds and central bank accounts, not into new business or consumer lending.

Put another way, the quantity of money is increasing, but its velocity is not. That’s because the new money isn’t getting into the hands of people who are just itching to spend it. But it will soon enough. And when it does, look for bond yields to rise and the great inflation to begin. Also, televisions and hookers.

“I think this will be the greatest time in my life to buy stocks at these prices. I just wish I had more capital,” said one of the attendees at the Doomer’s Ball last night on Southbank. We heard this sentiment time and again over the course of the evening. And there is no doubt that the valuations are good.

There is doubt, however, about what the Australian resource sector will look like in a world where capital is scarcer. Will it lead to a contraction in the number of viable firms? Is the credit crunch like a meteor strike that kills all the giant reptiles that fail to adapt to the new conditions? If it does, there will be a huge survivor bias favouring the stocks that remain.

But there was also some anxiety about further falls in stocks, especially the longer the bar was open at the Ball. One reader is forecasting another 20% fall on the ASX before the lows are in. In fact, if the All Ords reaches the 2003 lows (2,673) it’s a decline of 24% from today’s levels. If it overshoots that low–as markets tend to do when they correct–you’re looking at a thirty percent fall from current levels.

If you treat it as a thought experiment and ask yourself what would have to happen for the ASX to fall that much, you get some alarming possibilities. The liquidation of Oz Minerals? The dismemberment of Rio Tinto? The fall of a major investment bank or leveraged institution?

Or perhaps it’s something simpler: more falling prices for commodities. That’s what the World Bank seems to think anyway. As reported in the FT, the World Bank’s Global Economic Prospects report says the commodities boom has, “come to an end.” It adds that, “Over the longer run, the price of extracted commodities should fall.” It reckons slower population and income growth will contribute to slower resource demand growth.

Naturally, this is diametrically opposed to the logic of the boom that began in 1999. Then, you had 200 years of falling real prices for tangible goods seemingly reverse itself, mostly because of growth in global population and per capita income. So which thesis is right?

Well you know what we think. We think the Money Migration is the long-term transfer of the world’s wealth from the debt-based consumption economies of the West to the world’s savers and producers, roughly in the “East.” This certainly favours Aussie resources for at least a generation.

But the migration has been massively disrupted by the credit crisis, which is really just an epic attempt by the U.S. and other English-speaking economies to avoid their Day of Reckoning. But don’t you worry. That day is coming. It’s just taking longer than we originally thought. Ben Bernanke is a creative man. And he’s desperate too.

But why don’t we ask China what it thinks? After all, it’s a pretty important party to this discussion. China? What do you think? Hello China. Are you there?

Hmm. China is not taking our calls. Maybe that’s because some Chinese firms are too busy looking for ways to take advantage of the current situation by securing long-term supplies to resources at lower market prices. And maybe actions speak a lot louder than words about Chinese desire for Aussie resources.

“Shenzhen Zhongjin Lingnan Nonfemet Co., China’s fourth-biggest zinc producer by output, said it agreed to acquire a 50.1 percent stake in Australian miner Perilya Ltd. through a private placement,” reports Bloomberg. And Forbes reports that Chinese steel-makers are set to push for a major reduction in iron ore prices to reflect the fall in global steel prices.

The average price in October for a metric ton of iron ore fines, according to Forbes, was $US90.60. But Chinese steel makers reckon that with steel prices back at 1994 levels, iron ore prices should roll back to. In 1994, a metric ton of fines was US$20.40.

A lot has changed since 1994. Supply of ore is up. Demand is up too. But costs for resource producers are way up too. It’s unlikely the steel-makers are going to get a price cut that large. And if they do, it will put some smaller ore producers under enormous pressure (even harder to with stand if you don’t have access to credit).

Where are we then? A year ago BHP held the whip hand and chased Rio in a dream of grand ambition. Now BHP is reconsidering its strategy. Rio is reeling. And pricing power has switched back to resource consumers in China, who are eager to use the whip as well, it appears. There’s been a lot of whipping going on, hasn’t there? More on what it means tomorrow.

Finally, yes. We too saw the reports circulating that the International Monetary Fund is getting ready to dump a bunch of gold on the market. So far, we haven’t found anything to substantiate them. We’re looking around, and will report back on what Diggers and Drillers editor Al Robinson digs up as well. Until then…

Regards,
Dan Denning

December 15, 2008

The World Bank Goes Nuclear on Commodities was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.