Potash 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 big way. 

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.