By The Energy Report, on February 10th, 2012
 Major potash stocks are beginning to raise eyebrows with impressive profit margins. But as this developing market expands, industry giants will face competition from greenfield and brownfield projects in the works. In this exclusive interview with The Energy Report, Mackie Research Capital Analyst Jaret Anderson debriefs us on some fascinating development stories that are poised to change where and how the most successful potash producers operate.
The Energy Report: You last spoke with The Energy Report in June 2011. What has transpired in the fertilizer and potash business since then, both in Canada and in Brazil’s emerging market?
Jaret Anderson: The tail end of 2011 saw a period of weak demand for Canadian potash. Fourth-quarter shipments at Potash Corp. (POT:TSX; POT:NYSE) dropped by about one-third year over year (YOY). General concern over the economy gave dealers an incentive to avoid stocking up their warehouses, resulting in soft shipments, higher unit operating costs and quarterly earnings below expectations. However, Potash Corp. posted a 68% gross margin in its potash segment during the quarter, making it one of the most profitable publicly-traded businesses of this scale.
Meanwhile, Brazil overtook India as the top global importer of potash in 2011, with imports of about 7.5 million tons (Mt) KCl. This figure was up 21% YOY, drawing even more attention to the country’s chronic domestic potash deficit.
TER: What should fertilizer producers expect in the next few years?
JA: We’re going to see bullish prospects for fertilizer producers over the next 12–18 months. Demand for fertilizer products is likely to remain soft in Q112, but as the spring planting season in the northern hemisphere kicks into gear in Q212, we expect markets to tighten.
TER: You put out a report last December showing a fairly large global number of both new and expansion projects in the works. How will these projects affect the supply and demand equation over the next five years?
JA: We actively track 19 different brownfield expansion projects and 26 different greenfield projects around the world, totaling ~67 Mt of planned capacity. If all of those projects were built on the timelines put forward by their respective owners, we would see a massive glut of capacity in the back half of this decade. The reality, though, is that only the best of these projects are going to be built, and those are likely to experience significant delays compared to their projected timelines. Potash demand in 2011 was about 55 Mt. If we assume demand growth of 3%/year for the remainder of the decade, that implies we’ll need an incremental 17 Mt of supply by 2020 in order to maintain operating rates at 2011 levels. That is pretty close to the 20 Mt of brownfield projects currently on the drawing board. Any demand growth beyond this 3% level or further delays of brownfield projects would tighten markets further.
TER: You don’t expect an oversupply or downward price pressure?
JA: In any commodity, things don’t go up forever. At some point, the supply-demand balance is going to shift in favor of the buyers. The next several years however, look very positive for potash producers.
TER: Saskatchewan is the potash capital of North America, and although it’s a major supplier to other parts of the world, the North American market is relatively mature. What North American potash companies are still attractive buys at this time?
JA: In my view, the most attractive greenfield potash project in Saskatchewan is Milestone, which is being developed by a company called Western Potash Corp. (WPX:TSX.V). The company has a very large in situ resource of about 3.5 billion tons (Bt) KCl and has the highest grade of any existing solution-potash mine in Saskatchewan. Milestone looks very similar to the former Legacy project of Potash One Inc., which was purchased by K+S Potash Canada (SDFG:FKFT) in November 2010 for $434 million (M). At a market cap of $200M today, we believe Western Potash represents the lowest-risk greenfield potash company in the world, with a very attractive valuation.
TER: Another Saskatchewan company you’ve discussed in the past is Karnalyte Resources Inc. (KRN:TSX). It is developing a relatively low-cost, solution-mining project. What are your thoughts on the company’s risk-reward ratio?
JA: Karnalyte is focused on a different type of project that will seek to extract carnallite mineralization at its Wynyard property. While its carnallite mineralization is only about half the grade of a project like Milestone, Karnalyte’s engineers have designed a plant that can be built in stages, which offers some advantages in terms of capital expenditures. Karnalyte’s shares suffered a significant decline in December after the company pulled a $115M financing. We upgraded the shares from “Hold” to “Buy” during December and believe that below $10/share, the company represents good value. However, it may be difficult to see performance for Karnalyte until it successfully raises capital to begin construction at its Wynyard project in the spring.
TER: Are its prospects reasonable for the company as long as the market holds up?
JA: Its shares now represent good value. That said, I believe Western has a more attractive valuation and project than Karnalyte. But there is a difference between a good project and a good stock. Because Karnalyte has taken a large hit of late, it has some decent upside, especially below $10/share.
TER: You recently visited Brazil to get a little better picture of the country’s fertilizer business. That’s a very large, growing market. Tell us what you learned.
JA: Each time I visit Brazil, I come away with more anecdotes that convince me of the need to find ways to invest in Brazil’s agricultural future. Brazil has over 400 million hectares of arable land, but uses less than 15% of it today for agricultural purposes. It is the largest global exporter of beef, poultry, sugar, coffee and orange juice, and that production should grow for many decades. The problem is that its Cerrado region is generally nutrient-poor and requires significant quantities of fertilizer. Brazil has only one operating potash mine and imports more than 90% of the potash it consumes. In 2011, Brazil was the world’s largest importer of potash, at about 7.5 Mt. The Brazilian government has set a goal of becoming fertilizer independent by the end of this decade and we believe investors should be looking for ways to gain exposure to Brazilian agriculture and fertilizer markets.
To that end, two companies we’ve focused on are Verde Potash (NPK:TSX.V) and Rio Verde Minerals Development Corp. (RVD:TSX). Verde Potash controls the Cerrado Verde project in Minas Gerais state, which contains a large, at-surface deposit of potash-rich verdete slate. The company has developed and patented a process to convert verdete slate into KCl, the same standardized product that’s produced in Saskatchewan and Russia today. This is known as the Cambridge process. It’s very exciting, as it could allow for large-scale potash production in Brazil from an open-pit operation—something that hasn’t been done anywhere in the world.
Verde Potash recently published a Preliminary Economic Analysis that indicated an operating cost of US$274/t during the early years of production, ramping up to $291/t over the 30 year life of mine as the stripping ratio increases. That would give Verde Potash the lowest delivered cash costs to Brazil of any large-scale competitor globally. The potash producers in Canada and Russia have lower operating costs, but face very large transportation costs to deliver product to farmers in Brazil. Capital costs for Verde Potash’s project are estimated at US$800/t, which is about 25% below a typical greenfield solution mining project in Saskatchewan. Based on these attractive economics, we recently increased our 12-month target to $19.00/share. With the stock trading at about $7.00/share today, this is a very interesting story.
Another name we believe offers good exposure to Brazil is Rio Verde Minerals, which controls a land package near Aracaju in Northern Brazil. It is located adjacent to Taquari-Vassouras, the only operating potash mine in Brazil. Rio Verde is still at an early stage of development, having completed drilling on its first drill hole in November. We visited the site a couple of months ago and inspected the core. We await assay results from that hole. Rio Verde plans to drill three holes at its Sergipe potash property and to publish an NI 43-101 resource during Q212. Given the strong outlook for good potash grades on the property and the company’s ideal location in Brazil, with nearby access to a port, roads, power and natural gas, Rio Verde looks to us to offer excellent risk-reward at current levels. Based on our target of $1.30/share, Rio Verde offers more upside to our target than any other company in our coverage universe.
TER: Can you elaborate on the Cambridge process you mentioned?
JA: In December 2010, Verde announced that it had patented a process to convert its verdete slate into KCl. This process was developed by Dr. Derek Fray at Cambridge University in the United Kingdom. This process was tested and optimized by Hazen Research in Denver, CO, and by FLSmidth in Allentown, PA, and SRK Consulting, which resulted in the publication of a Preliminary Economic Assesment in late January. We visited FLSmidth’s facilities in Pennsylvania last week and observed the process in operation. The process is relatively simple and bears many similarities to the cement production process. It employs a rotary kiln, like cement, but uses different inputs, namely Verde Potash’s verdete slate rock, limestone and salt. The Verde Potash KCL production process takes place at lower temperatures than that of cement, about 900C vs. cement at about 1,450C.
TER: Do you expect the Cambridge process to work on a commercial scale?
JA: It’s moved from a bench scale at a university to a pilot plant. To move to a commercial scale is another jump. Staff at FLSmidth and SRK have indicated to us that they typically see fewer problems with commercial scale facilities than they do with pilot plants. Every indication we have points to the commercial scale kiln as being well within the technical ability and experience of the teams at FLSmidth and SRK.
TER: There’s also been some development on the African continent, and a couple of Canadian juniors are working on projects there that are projected to go online in about five years. How are they progressing?
JA: Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX) and Ethiopian Potash Corp (FED:TSX.V; FED.WT:TSX.V) are both working to develop greenfield potash projects in the Danakil depression in Northern Ethiopia. Allana is the much better capitalized of the two companies. It has published a large NI 43-101 resource based on its successful drill program over the last couple of years. The projects in Ethiopia are interesting in that the high year-round temperatures in the Danakil may allow for solar evaporation, thereby materially lowering energy costs in the solution-mining process. Ethiopia is also located relatively close to China and India, two important potash consumers.
Ethiopian projects face a major challenge, however, in that the logistics of moving thousands of tons of potash per day from the project site to the port at Djibouti some 600 kilometers (km) away over roads of varying quality may be a significant hurdle. We believe the transportation costs will end up being materially higher than current estimates.
Both Allana and Ethiopian Potash have seen their share prices languish over recent months and are both near 52-week lows. We believe both stocks have room to move up as the projects are derisked and as Allana moves toward a feasibility study in August of this year. While Ethiopian Potash has more leverage to positive developments given its smaller enterprise value, it is a much riskier investment given its very low cash levels. Allana, on the other hand, has more than $65M in cash on its balance sheet, providing it with a lot of time and resources to derisk its project and make it more attractive to potential suitors.
TER: Will Allana rely on a rail link to be built in order to get its product to market?
JA: There are plans in Ethiopia to build a rail network in the country, and that rail network is planned to approach Allana’s project site. We’ve met with the minister of transportation in Ethiopia on this topic. That project is probably a number of years away from completion, and for at least the first several years of production, Allana is going to need to find a way to transport its product by road via truck. You can’t assume the rail network is going to be ready in the next few years, in our view.
TER: What effect will trucking the material have on the project economics?
JA: Trucking will be much less economic than a rail network. Allana has published its own cost estimates for transporting the product from its project site to the port at Djibouti. We find its estimate of $12/t to be very low. We see a number closer to $50/t, based on the figures we’ve seen at other operations in existence today, such as those in Saskatchewan.
TER: Do you have any other interesting stories that our readers might find useful?
JA: The potash industry today is generating very high cash flow and strong returns on capital for incumbent producers. Potash Corp. generated a gross margin in its potash business last year of 68%. Apple Computer, by comparison, posted a gross margin of 41% in its fiscal 2011. The levels of free cash flow generated by this business and the strong secular trends in agriculture are going to attract capital and will ultimately lead to new greenfield production. With so many companies chasing so few quality projects though, we would caution investors to think carefully about the merits of each individual project. The size and grade of the deposit, the infrastructure in place, the proximity to major potash-consuming countries and the geopolitical risk are all critical drivers of value.
TER: Do you see any further consolidation in this business at this point? Or is it still too early?
JA: We’ve had a lot of consolidation in this business. The successful business strategy that greenfield potash companies have employed in the past has been to identify a good project; then derisk it by defining the resource through engineering and feasibility studies to make it more attractive to well-capitalized companies. A number of greenfield potash companies have had success with that strategy by ultimately selling to large mining companies like BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Vale S.A. (VALE:NYSE) and Rio Tinto (RIO:NYSE; RIO:ASX). I think this process makes sense and is going to continue.
TER: What are your top picks at this point?
JA: Our top picks in the sector for 2012 are Verde Potash and Rio Verde Minerals. Both companies offer good leverage to the Brazilian fertilizer market and have the potential to generate meaningful returns to equity investors. By their nature, development-stage resource companies involve much more risk than an operating company. We believe, though, that 2012 is likely to see very strong results for the greenfield companies with the best-quality assets, in the right locations, with attractive valuations. In our view, Verde Potash and Rio Verde check all of those boxes.
TER: Thank you for your time.
JA: Thank you.
Jaret Anderson is a research analyst covering agriculture and fertilizer at Mackie Research Capital. Anderson has 13 years of experience in the investment industry and was rated #1 for earnings estimate accuracy by Starmine in 2006 and #2 for the quality of his reports in 2005. Prior to joining the firm in July 2011 Anderson worked at UBS Securities Canada where he covered Canadian paper and forest companies, as well as chemical and fertilizer industries. Most recently Anderson covered Canadian fertilizer and chemical companies for Salman Partners. He received a Bachelor of Commerce, with honours (Finance) from the University of British Columbia, and was awarded the CFA designation in 2000.
By The Energy Report, on October 7th, 2011
 Despite the risks and unfavorable public opinion associated with offshore drilling, the truth remains that the keys to unlock the planet’s vast remaining oil resources lie beneath ocean floors, in places like the Gulf of Mexico, Brazil and even the Arctic. In this exclusive interview with The Energy Report, noted commodities expert Amine Bouchentouf tells us why he likes the prospects for oil explorers and producers and how the potash business is fueling food production for a growing world.
The Energy Report: Thank you for joining us this afternoon Amine. You wrote Commodities for Dummies and are a partner in Commodities Investors LLC, an advisory firm. What prompted you to reach out to a non-expert audience?
Amine Bouchentouf: I started investing in commodities around the year 2000, and in 2005 we saw an explosion of products for retail and institutional investors covering the commodities markets. In conjunction with that, I also noticed a lack of information for investors about commodities. That’s how Commodities for Dummies was born; it’s a one-stop guide for investors looking to get exposure to commodities. Why the “For Dummies” series? I felt it’s the Walt Disney of guide books: helpful, easy-to-understand and trusted by everyone. Since I wanted to provide investors with insightful, unbiased and trustworthy advice on different commodities, it made a lot of sense to partner with the series. Oil, natural gas, coal and fertilizers are all part of the commodities that I cover in-depth in my book.
The first edition came out in 2007 and a second edition this year. The book has done extremely well and is really a testament to the growing demand for our industry and for hard assets in general.
TER: Concerns about global population growth and demand for higher-quality food in developing economies have made the fertilizer market a hot topic. What should the average retail investor know about this sector?
AB: The fertilizer space is extremely interesting. If you want to get the broadest exposure to agribusiness then you have got to look at the fertilizer space, which gives you exposure to everything from coffee and orange juice to cattle and corn. The United Nations is predicting a population explosion between now and 2050. With that comes a natural rise in food demand. As we’re increasing available acreage to produce grains and livestock, we need fertilizers to increase yields and make larger-scale agriculture possible in hard-to-farm climates. The fertilizer market was relatively weak 10 years ago, but we’ve since seen prices start to go sky-high in response to increased demand.
If you want a long-term play in hard assets, the fertilizer market is a great way to get exposure to the commodity and agribusiness story. I’ve been looking at the space for a long time and I first recommended Potash Corp. (POT:TSX; POT:NYSE) when it was $12 a share. Had you followed my recommendation you would be sitting on returns of 420%. Now I’m in the process of looking for the next Potash Corp. Which company is going to provide me with that kind of explosive growth? There are certainly a few candidates out there. Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX) is very interesting. The company has operations in Ethiopia, which gives you a unique access point to Africa, the Middle East and Southeast Asia—some of the world’s fastest growing economic blocks. You’d be surprised to know that the infrastructure in Ethiopia is world-class, with modern port, railway and road infrastructure. In addition, the mining laws are very friendly. Finally, the operating costs are low since the potash deposits in Ethiopia are near the surface, only about 100 meters (m) from the surface.
Another company worth a look is Karnalyte Resources Inc. (KRN:TSX). This is an exploration and development company that has potential to build a 2 Mt./year potash facility. It has very strong industry fundamentals and an experienced management team. It can provide you with a good solid exposure to this space.
TER: Where are they located?
AB: They’re up in Saskatchewan with over 85,000 acres of property. Their Wynard Carnallite project is an exploration and early stage pre-development property with a main zone of carnallite and sylvinite, which are minerals containing potassium. The attractive thing about this project is that they will be using what is called “solution mining,” which involves pumping a fluid into the mineral deposit through a drilled well. The carnallite mineral containing the potassium dissolves in this fluid to form a brine solution, which is pumped back to the surface. The potassium and magnesium minerals are then recovered from the solution and processed. Compared to conventional mining methods, this mining process has lower capital costs, shorter time to production, and lower environmental impact.
TER: Have any other companies in that field caught your eye?
AB: One of the best places for agribusiness in the world is Brazil. Brazil is essentially the “Saudi Arabia” of food since it has tremendous water resources and fertile land. I’ve been spending quite a lot of time in Brazil and it’s really a spectacular country to invest in. Brazil is currently the world’s second-largest importer of nitrogen, phosphates and potassium, the three principal chemicals used as fertilizers. The internal demand market is there and the deposits are there, so it makes sense for companies to exploit the potash resources inside the country.
There are a couple of companies in the Brazilian fertilizer space that are worth looking at. Verde Potash (NPK:TSX.V) is an interesting play. Verde has both conventional potash and thermo-potash projects in the state of Minas Gerais, the greenbelt of Brazil’s fertilizer market. They also have developed a new technology in association with Cambridge University in the U.K. to combine potassium with a mixture of salts to create water-soluble potash. If the technology is proven to be economically viable it could create a lot of upside for investors.
Another interesting company is Potassio do Brasil, which is still in pre-IPO mode. It has large reserves in the Amazon region, which shares similar potash characteristics to the world-renowned Saskatchewan basin of Canada. It has mineral rights along 400km in the Amazon basin, close to the 1.1 billion ton (Bt.) Petrobras property, and it also has an active drilling and exploration program. This is a company I’m keeping an eye on.
TER: Oil has been bouncing around in the $80-$100/barrel range for the past year. Where do you think oil is headed, and what opportunities do you see in this space?
AB: Oil is one of my favorite commodities because it is such a global business and it is such a challenging business. Right now I want to see how the situation in Europe develops. At the same time, it’s important to look at the demand side. If Europe blows up, what happens to demand from Europe and what are the spillover effects in the United States and China? The demand picture is still robust in emerging markets. China has become one of the big drivers of oil demand growth along with India and the United States. The United States is still the largest consumer of oil in the world. That’s an important fact to keep in mind. Supply-side disruption, whether in Nigeria or Libya or wherever else, can really send prices forward. On a macro level, I do think OPEC has done a terrific job of managing expectations and has been able to meet demand in a steady and consistent manner.
As far as specific plays, I’m always looking in the energy/equity space for oil companies that can provide good exposure. The offshore exploration companies offer interesting opportunities. Brazil, for example, announced major discoveries by Petrobras (PBR:NYSE) in its pre-salt basins. This has the potential to catapult Brazil into the top-three holders of oil reserves in the world. The exploration upside can be tremendous. Companies such as Transocean Ltd. (RIG:NYSE; RIGN:SIX), Noble Energy, Inc. (NBL:NYSE), Diamond Offshore Drilling Inc. (DO:NYSE) and Hercules Offshore Inc. (HERO:NASDAQ) can provide significant upside. Noble, for example, is already growing and its day rates are increasing. If you want to get more regional exposure, you can always look at Hercules Offshore, which provides Gulf of Mexico exposure. After the BP Plc. (BP:NYSE; BP:LSE) oil spill, we saw permitting essentially grind to a halt. The federal government had a public relations and environmental nightmare on its hands. So it was not going to move forward with permitting drilling activity in the Gulf of Mexico at that time. Now we’re seeing permitting come back to normal levels. It’s not quite to pre-BP oil spill levels but it’s getting close. A company such as Hercules Offshore, which had made some solid acquisitions in that region, gives you exposure as regulations relax.
Another area that is off the radar screen of investors is the Arctic, which can provide tremendous upside. The U.S. Geological Survey estimates that there may be up to 450 bbl. of oil equivalent in the Arctic, which is like discovering two Saudi Arabias of oil! We saw in September Exxon Mobil Corp. (XOM:NYSE) and Rosneft Oil (ROSNS:RTS), one of Russia’s biggest oil companies and one of the top majors in the world, sign an exploration agreement to go up to the Arctic and start a $2.2B exploration campaign. They’re expecting to find very, very large reserves up in the Arctic, close to 50 billion barrels (bbl.) of crude, which is just a gigantic number—that’s the equivalent of bringing another Libya into the market. Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) has been present in the Arctic for three decades and has some interesting activities there; in fact Shell is set to begin an extensive drilling program in the Alaskan Arctic that could yield some large discoveries.
Another company I like that can give you pure Arctic exposure is Cairn Energy Plc. (CNE.L:LSE). Cairn is a Scottish company that has been active in Southeast Asia for a long time and has had tremendous success there. They’ve discovered offshore wells near Bangladesh and India and have a proven track record of creating shareholder value. Cairn has now shifted its focus towards the Arctic. This is another exploration and production company that can get that upside Arctic exposure you’re looking for.
TER: Are there any other spaces in the market you’re watching?
AB: I think the MLP (master limited partnership) space is very interesting. It’s not a space that a lot of people understand. As an investor, I like MLPs because they provide you with two things: physical commodity exposure and high yields. An MLP will distribute all of its cash back to its shareholders. It’s not uncommon to see MLPs that have yields of 8%, 10% and in some unusual cases as high as 18%. I believe a company such as Enbridge Energy Partners, L.P. (EEP/EEQ:NYSE) is a good way to get MLP exposure. They’re in crude oil and natural gas as well as transportation and storage, with really great exposure to the energy basin of North America. I think the company is going to deploy a lot of capital to grow a lot of different projects, especially in the Bakken Shale, which is an area that you have to be in as an investor. I highly recommend investors take a look at Enbridge as an MLP with some solid yields.
Another area I like is the LNG space. I think Teekay LNG Partners, L.P. (TGP:NYSE) is a world-class LNG company. We saw them provide a large cash distribution in the second quarter. Their yield right now is at about 7½%. In addition, it’s acquiring four more LNG carriers between now and 2012. I think these capital expenditure investments are going to generate a lot of cash-flow for the company going forward. Teekay and Enbridge are both solid companies.
TER: What final thoughts do you have that our readers can take away as far as the whole commodity sector and energy in particular?
AB: The energy space is wide and vast. You have to be very selective as to which type of assets you want to be in. You can find some tremendous upside in the mid-cap space as well as in the small caps and the offshore drillers. But, you have to be very, very selective. That said, my forecast for energy, particularly oil, is upward. The supply situation remains very tight and the demand from Asia and emerging markets is rising. If you want to benefit, you have to invest in specific companies.
TER: Thanks for your time, Amine, and the valuable insights you’re provided for our readers.
AB: Thanks for having me.
Amine Bouchentouf is a best-selling author and globally recognized expert in the commodities markets. He is the author of the best-seller Commodities for Dummies, (Wiley), which provides factual insight and analysis on energy, metals and agribusiness. Amine’s market reports and recommendations are read by over 42,000 investors each month. He is also a founder of Commodities Investors LLC, an advisory firm that advises investors on investment allocations into natural resources. He is fluent in English, French, Arabic and Portuguese and graduated from Middlebury College with a degree in economics. You can follow him on www.commodities-investors.com, www.hardassetsinvestor.com/the-commodity-investor and www.twitter.com/commodityinvst. Please feel free to email him with any inquiries at: amine@commodities-investors.com.
By The Energy Report, on September 30th, 2011
 It may not sparkle or shine, but fertilizer has a bright future. In this exclusive interview with The Energy Report, Bruno del Ama, CEO of Global X Funds, tells us why investors should be looking at this “growing” industry and how his company’s new global fertilizer and potash ETF (NYSE:SOIL) provides a great vehicle for profit. He also tells us why his company’s gold and silver mining ETFs are poised to catch up with precious metal market performance.
The Energy Report: Thank you for joining us this morning, Bruno. Before we get into the details of Global X Fertilizers/Potash ETF (SOIL:NYSE), let’s discuss ETF basics and how they operate.
Bruno del Ama: Certainly. Exchange traded funds (ETFs) are fairly similar to traditional mutual funds. Their name indicates their main difference—they actually trade on an exchange like any other stock. ETFs have been one of the fastest-growing segments in the financial services industry. That’s due to many of the benefits ETFs offer, such as low cost, transparency and tax efficiency.
TER: This really is a proliferating field. It seems like every time we turn around there’s a new ETF. What factors does Global X Funds consider when developing an ETF for a particular sector?
BdA: We focus on three very important factors when we decide to bring new products to market. The first starts with the global macro trends. What are the big themes that are shaping the world? Our products have to fit into those very long-term secular trends that will continue to drive performance.
The second one is that it has to be unique and differentiated. So, if you look at the lineup of Global X Funds, there are essentially no products like them. And thirdly, the products in the ETF package must make sense and provide good access to the type of market that we’re considering.
TER: How long has Global been managing ETFs?
BdA: We brought our first ETF to market in February 2009, and we have been ranked by BlackRock as one of the fastest-growing ETF companies in the world. We currently have about $1.5 billion (B) in assets under management and have been ranked by our peers both in Europe and the U.S. as the most innovative ETF company in North America.
TER: What are the advantages for investors buying an ETF versus other investment vehicles?
BdA: The main reason why ETFs have been very popular is their low cost. Their management fees are much lower than those of comparable mutual funds. ETFs also don’t have the loads, distribution and short-term redemption charges that mutual funds typically incur. They’re very cost efficient. Essentially, what ETFs do is bring institutional-like expense ratios to the retail investor. However, about half of the user base for ETFs is institutional so these products have to work well for both investor classes. The retail investor can essentially piggyback off the institutional investor and get access to the exact same expense loads. That has been a huge driver of growth.
Innovation, as you point out, has been another driver of growth. The fact that you can get access to areas of the world that were very difficult to access before is a huge benefit. For example, we have a whole suite of China sector funds. So, if you have a particular view on the China consumer segment, that’s something that you can now place targeted bets on, which was very difficult, if not impossible before ETFs emerged.
The third benefit of ETFs is their tax efficiency. Additionally, market volatility has made the liquidity ETFs offer very appealing. If you have the market swinging up or down 300 basis points on any given day, you can come in at 11:00 a.m. and you then sell your shares at 3:00 p.m.
Transparency is yet another benefit of ETF investment. One of the problems in the market in 2008 was that a lot of investors in mutual funds didn’t know exactly what they owned. In our case, as well as with most ETFs, you can go into our website and see all of the holdings updated daily for any particular ETF.
TER: Typically, how much trading occurs in these funds?
BdA: Essentially 90%–95% of ETFs are what’s called passive funds. They track indexes developed and maintained by a third-party, such as Standard & Poor’s, Dow Jones, FTSE, etcetera, and those indexes don’t change very often. They’re typically rebalanced two or four times a year. There’s not a lot of trading that takes place. Of course, you could have corporate actions within a quarter where a couple of companies within the index merge or there’s a spinoff. There’s some amount of trading that happens inter-quarter between rebalance dates, but these funds provide exposure to a complete market in a passive way.
TER: So why did you start this particular potash and fertilizer ETF?
BdA: The only way to invest in the fertilizers/potash market is to buy individual stocks, most of which actually trade on foreign exchanges. This ETF allows investors to get diversified exposure to the whole fertilizers/potash sector, including stocks from 15 different markets, including Israel, Australia and China, to name a few. We had received inquiries from institutional investors looking for a simple and cost-effective vehicle to invest in the fertilizer/potash market. These investors are driven by the significant growth in the food and agro business market. Fertilizers are the nutrients that farmers require to increase crop yields, and as such, they are the first link in the global food supply chain.
TER: What are your growth expectations for this sector?
BdA: The prospects for continued growth in the fertilizer/potash business are very compelling. Purchasing power growth and the result of diet shifts in emerging markets are driving crop usage from grains toward high-protein feed, fruits and vegetables, which require about double the average application rate of fertilizers. The resulting growth in crop yields is enormous. For example, grain yields in India are less than one-half of those in the U.S., with lack of proper fertilization being the key reason.
TER: So the big markets are overseas. Is the North American market relatively saturated in terms of fertilizer usage?
BdA: Yes and no. I wouldn’t call it saturation, because the U.S. is a big farming country and you continue to see growth in farming. But, certainly from a fertilizer use perspective, the U.S. is a much more efficient market and so the penetration of fertilizer is very high. Emerging markets such as India have low penetration of fertilizer, so there’s a lot of catching-up that has to take place.
TER: Can you give us a little more of the specifics on your new Global X Fertilizers/Potash ETF?
BdA: Our Fertilizer/Potash ETF invests in the largest and most liquid companies involved in the fertilizer sector globally. It currently includes 29 companies from 15 different countries. What’s unique about this sector is that it sits at the intersection of commodities and agro business—probably two of the most significant bull markets currently taking place.
TER: Are there any other similar funds out there at this point?
BdA: There is nothing else focused on these markets specifically. There is a fund that invests in the broader agro business market. They may have a quarter of their exposure to the fertilizers market but it’s more diversified and includes farming operation and equipment. Ours is the only fund that has focused exposure on just the commodity/fertilizer aspect of the agro business market.
TER: You have a very geographically diverse group of stocks and most of them are companies that most investors have never heard of. Are there certain countries and regions that appear to be performing better at this point than others?
BdA: The emerging markets will clearly be the key engine of growth. Asia and Latin America already account for about two-thirds of global consumption of fertilizers to support food production for their large, growing populations. Global fertilizer consumption is growing fastest in these emerging markets with historical annual growth rates of more than 3% over the last 15 years. China and India specifically will be the key engines of growth. Annual consumption in China, for example, is expected to return to their pre-2008 growth levels of nearly 10% per year. Major growth has been taking place and will continue to take place in emerging markets.
TER: Are companies based outside of emerging markets included to provide geographical balance?
BdA: The fund represents the full fertilizer market, wherever those companies are located. China imports about 70% of the fertilizer they use. So, when you look at some of the names of companies in the U.S. or Israel, you know that some of their production is consumed at home but a big percentage of it is exported, primarily to emerging markets. There is a tremendous amount of trade and export taking place. Even by investing in some of the Australian or U.S. names, you will get access to the emerging markets. Obviously, when you invest in some of the fertilizer companies that are physically located in places like China, they’re expected to generate outsized growth because their local market is growing the fastest.
TER: What are some stocks our readers might find interesting on an individual basis?
BdA: As a fund manager, we don’t necessarily provide recommendations on single names. Most of these stocks are in foreign markets, but there are a handful of stocks that can be bought on U.S. exchanges, including CF Industries Holdings Inc. (CF:NYSE), Intrepid Potash, Inc. (IPI:NYSE), The Mosaic Company (MOS:NYSE), Scotts Miracle-Gro Co. (SMG:NYSE) and Terra Nitrogen Co., L.P. (TNH:NYSE). There’s also one Chilean fertilizer company that can be bought as an ADR, Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX; SQM-A).
As a whole, this is clearly a growth market, and valuations will reflect the growth dynamics that are taking place. We certainly believe that this is a great market to be in going forward.
TER: What are some of the other ETFs that Global X Funds manages?
BdA: Global X Funds operates, perhaps, the broadest suite of commodity producer ETFs across a number of markets, including gold, silver, copper, aluminum, lithium, uranium and oil. The best performing of our funds has been the Global X Pure Gold Miners ETF (GGGG:NYSE), which is a relatively new fund launched in March of this year. It tracks the Solactive Global Pure Gold Miners Index and provides exposure to companies that generate the vast majority of their revenues from gold mining. The other fund that has performed well is the Global X Silver Miners ETF (SIL:NYSE), which tracks the Solactive Global Silver Miners Index and is currently our largest fund with around $500M in assets under management.
TER: Do you have any other food for thought for our readers?
BdA: The one observation I would make is that when considering investing in the commodities space and precious metals miners in particular, you have seen relative underperformance for the miners relative to the physical metal. We are big believers in investing in the commodities markets through mining stocks and producers for a number of reasons. Reason number one is that these are operating companies, and even in an environment where commodity prices are flat, they’re still generating revenues, earnings and growth. They’re paying dividends so they’re income-producing, as opposed to the metal itself, which doesn’t pay any dividends. We see an opportunity in this relatively underperforming market for the miners. Gold and silver miners have done pretty well, but not as well as gold or silver itself. A lot of it is driven by the analysts not factoring in the current high gold and silver prices into the earnings forecasts of these companies because they do not expect them to remain at those levels.
If you think about that dynamic, three things can happen: If the price of gold remains at the level where it is, a fund that invests in physical gold wouldn’t go anywhere because the price is not going up. But as the price stays at that level, the analysts are going to start factoring in those price levels into their earnings forecasts, so the price of the miners should go up while the prices of the physical gold stays flat. In an environment where the price of gold itself goes down, the physical gold ETF performance will be down. At that point, the miners have an advantage because they haven’t factored in that higher gold price into the expectations so they should perform relatively better.
If the price of gold goes up, the physical gold ETF should go up. But that should also factor into the miners, who typically have had an exponential return relative to the price of gold because their costs remain relatively flat while their earnings go up. They have a leveraged return versus the physical metal, and this is a good time to look at the metal producers as opposed to the physical metal as an investment. Our clients are very well positioned to benefit from that exposure.
TER: We appreciate your time and insights today.
BdA: Thank you for having me.
Bruno del Ama is the cofounder and CEO of New York-based asset manager Global X Funds, which has $1.5 billion in assets under management. Previously, he served as head of operations in the structured products business at Radian Asset Assurance, and was a senior consultant at Oliver Wyman. He is a CFA charter holder and received his MBA from the Wharton Business School.
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By The Energy Report, on August 31st, 2011
 The recent tumultuous downturn in stocks has created deeper values and new opportunity in the agricultural space. Dahlman Rose & Co. Managing Director Charles Neivert is a near-term bull on fertilizer companies, but the window could close and diminish prospects in the not too distant future. In this exclusive interview with The Energy Report, Charles talks about the complex dynamics that affect the farming and fertilizer industries, and reveals his best pick for a core holding.
The Energy Report: Charles, I was looking at an un-weighted basket of fertilizer stocks, and they were down about 23-24% for the last week of July through the first six trading days of August. Has this opened up some tremendous value for investors? Or is this downturn signaling a commensurate slowdown in agriculture along with the general economy?
Charles Neivert: I think that as a group this is probably more of a signal of a very strong value for investors over the next three to six months—possibly longer than that depending on the company. We don’t see a great change in the agricultural landscape due to the changing economy. It is certainly part of the things going on, but it may have less bearing on the fertilizer names than some other material spaces. That’s simply because food is involved and the grain crop out there that may have been damaged in some ways—though possibly not quite as definitive as we might see in other products. As a result, we think there is a lot of value in the fertilizers.
TER: The key difference is that it’s food?
CN: Yes. The demand for food is less elastic. Certain amounts of food are needed to keep going and global inventory is limited. This year, a number of grain crops were not exceptionally large. As a result, we don’t see a big rebuilding of inventories. The potential is that the price of some of these grains could continue to go up if the harvest does not come up. So, you could see things going up even though the economy is backing off simply because supply is being cut away.
TER: It sounds like you are near-term bullish on some fertilizer names, but that you have longer-term fundamental concerns.
CN: Yes, that is the case. Company prospects really depend on which nutrient is involved during which timeframe. The near-term is very good, I think, for any nutrient given the food and grain situation. However, as you mentioned, fundamentals for some of these products could potentially deteriorate over time while others are likely to be stronger for a little bit longer.
Again, given the nature of the agriculture business, it is really difficult to have a very long-term outlook within the context of a potentially extremely volatile production range, meaning grains. That is because the grains can go anywhere from very, very large harvest years to rather challenged times without any real rhyme or reason. There are no traditional business cycles. The agricultural cycles are all based on weather. If weather is extremely cooperative across a broad range of geographies, you could have an enormously large crop at a time when you don’t really want an enormously large crop. You may already have inventories, but there is not much you can do about it.
You might also get a small crop on top of small inventories, or something in-between. You don’t have the same control, particularly on the supply side, as you do with a manufacturing operation that can back off production when inventories are long. For the most part, the rules that governments have put into place to enforce land set-asides to help control production, have largely been abandoned. Those policies are no longer used, particularly in the U.S. and even in some other areas. So, you can get large or small crops completely opposite of what you might want or need at that time.
TER: Let me just flip here to the macro-economy for a moment. In a detailed statement following a meeting of the Federal Open Market Committee on August 9, the Fed signaled a prolonged period of slow growth and, in an extraordinary comment, said that interest rates are expected to remain low until mid-2013. How does this affect the agricultural universe?
CN: Well, those rates are pretty much focused on the United States. So, I don’t think it really has that much of an impact on the Ag space. In fact, it may have none. Low interest rates, to the extent that they affect the dollar could present some potential challenges because the dollar is weak or because the dollar is strong. That does have a lot to do with corn or soybean costs to potential importers of U.S. products versus some competitors. But, it will have nothing or little to do with what the farmer is going to plant in any given year.
TER: Charles, what are your institutional investor clients telling you now during this selloff? Are they holding off on buying stocks for fear of needing cash for redemptions at this point?
CN: Each portfolio manager may take a different tack, so really this one is a little hard to answer. My guess is that now people are moving and seem to like the Ag space for the time being. We are seeing good activity. A lot of it is to the buy side where activity levels are good.
TER: Can a case be made that some of these plant nutrient producers are defensive stocks?
CN: In the current environment, you can make that argument. They are not typically defensive in the way you think of a food stock in a recession. In a recession, these guys get hit. When grain production is being challenged, they become defensive opportunities.
TER: Potash is traded in a negotiated market, not a globally efficient and tight market. But we have seen some transactions of $490/ton in India. Could this represent an upward trend?
CN: Well, the price of this product has been coming up for over a year now as demand has come back from the trough of 2009. I won’t say it’s impinging on capacity, but it starts to be a snug market because we have run through a fair amount of inventory over the last year to a year-and-a-half. That is what ultimately justifies the fertilizer price. For the sake of argument, if this year’s crop turned out to be extremely large and we rebuilt inventories substantially, fertilizer pricing would have a very tough time going up from here. By the same token, if the crop comes in short, and the way it’s looking, it would increase the price of grains and therefore be a bit supportive of a price increase in potash. What we found in 2008 was that crop price is a very important determinant in what the fertilizer price can ultimately do.
TER: Are you currently bullish on potash as a commodity?
CN: No. Near term I like all the names and products, but on a longer-term basis, I’m not as bullish. I see an awful lot of capacity on the horizon. Some has begun to come up and more is coming over the next few years. It will be a pretty steady stream from a very wide variety of potential producers and some new entrants.
TER: At what price-per-ton would you be bullish on potash equities generally?
CN: I don’t look at the price of the product as a sign at all. I look at the price and prospect for the grains and consider what needs to happen from that point. So, when grains are at low prices and the crop is looking strong, I’m not going to be bullish.
TER: Is the extraordinary heat wave in the U.S. affecting crops?
CN: It’s definitely affecting crops. The timing of the heat wave is also an issue. If you get periodic rain, it reduces that impact. But, there are times where heat can be extremely damaging and other times when it’s less damaging. If heat hits at certain points of the growth cycle, plants can be far more damaged than at other stages of their growth. The heat that came through the Midwest earlier in the year hit around a time when certain plants were going through a key stage maturation, and that can be a problem.
TER: Is there a play for investors on drought-resistant crops?
CN: Seeds haven’t yet gotten there. There is no seed out with the label of drought-tolerant. It’s hard to say resistant. It’s really a matter of degrees. If you get no water, nothing will help you. But, if you get smaller amounts than normal, some seeds under development will still produce near- or full-yields under less-than-ideal conditions, but they are not in the market yet. They are within a few years, so the claim goes, and we will see when they make it. All the major seed players are working on that particular trait. You can get into the companies that would provide that pipeline by looking at the typical seed names of the world—du Pont de Nemours & Company (NYSE:DD) and Monsanto Company (NYSE:MON).
TER: Low equity prices have left a lot of companies with cash on their balance sheets. What does this bode for M&A activity?
CN: It’s a tough call. It depends on the product because some of the markets may be so consolidated already that it will be difficult to get anything by the antitrust people. Cheap prices may or may not allow for acquisition because people will look at the price from six weeks ago for comparison. A perfect example is what PotashCorp (TSX:POT; NYSE:POT) went through when BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) took a run at them. The stock was down in the high ’80s to low ’90s for a long time. BHP was thinking it could get the company for $130, but just before the offer, PotashCorp’s share price went up to $106 because the wheat market in Russia started to give way. Russia was experiencing a serious drought. The prices started to move up, and even though the $130 offer was actually still a pretty substantial premium, it was not accepted. Not only was it not accepted by the company, but, as conditions in the grain marketplace worsened with stress from the U.S. corn crop, that price got even higher. So, it easily surpassed the offer number. Either people were expecting a much higher bid, or something is going on that makes the stock just worth more—like getting another bid. When the BHP bid was pulled, the stock didn’t drop.
TER: What are you telling your clients right now Charles? Where are the value and the growth stories?
CN: The name we like the most in the group is CF Industries Holdings Inc. (NYSE:CF) because we see the pressure on the corn crop in particular leading to a very positive, constructive situation for corn into 2012. The biggest beneficiary of a corn crop that needs to have a very large planting is more likely to be a name that is heavy in nitrogen, as opposed to one heavy in potash and phosphate.
We think there is going to be a fairly significant increase in corn acres planted next year, and if you need acres in corn, the U.S. doesn’t have a lot of new, unplanted acres to go after and would have to probably use acres currently in another crop. Often that tradeoff is in soybeans, which would result in an increase in the application of nitrogen.
TER: Even in this downturn, CF Industries is still up 82% over the past 12 months and it’s flat over the past month. So, it’s held up pretty well under this pressure.
CN: CF Industries is our only straight-out buy. We’ve been recommending this stock for a long time. Even when I was less constructive on the industry, this was the name we liked the best.
TER: Even though CF Industries is your only straight out buy-rated stock, you still recommend that money managers create a basket of these stocks, do you not?
CN: Right.
TER: And, what would that basket include?
CN: We are sort of constructive on all the fertilizer names, at least through the fall application season and possibly a bit beyond. CF is only in nitrogen with some phosphate exposure and no potash exposure. So, we would tell people to get some potash exposure, but pick your name carefully. We lean toward PotashCorp as a name, but you have to look at it at that moment in time and see how the company is performing against The Mosaic Company (NYSE:MOS) or Intrepid Potash Inc. (NYSE:IPI). It’s really a close call based on a lot of different metrics. That is why we recommend a basket within the group to your preferred weighting. You have to own some of everything, but include some of all of the nutrients. You could cover it all with two or three stocks in the basket.
We have upgraded the entire industry to an attractive level, and in a strong agricultural situation, you don’t want to be left completely unexposed to one particular nutrient because they will all move well and you want to catch some of that. It’s always hard to tell which one will be the best of the group.
TER: These companies are all mid- and large-cap. Are there any small- or smaller caps under a billion dollars where investors might be able to get a little more leverage?
CN: The only one that I deal with that gets down close to that range is CVR Partners LP (NYSE:UAN). It is a pure play on the nitrogen side structures as an MLP (Master Limited Partnership). It features a good payout, but tends to mute the share price a bit.
TER: Want to mention any other phosphate, potash or nitrogen companies?
CN: The only company I haven’t mentioned in the universe is Agrium Inc. (NYSE:AGU). I hesitate to use the word defensive play, but it has a big retail operation that it uses very effectively to move an awful lot of product. It does very nicely in that business. It is also spread across all the nutrients. It has nitrogen, potash and phosphate exposure. It also happens to be based-in and sell a lot of product in Canada, which means that it is a bit isolated from the rest of the market. That actually gives the company a pricing advantage because the market up there is a bit higher-priced. Its big retail exposure is sometimes a little bit of a turnoff if what you are trying to do is play the fertilizer space in a pure way. It’s a good company and well run. But, people tend to look at it and say it’s not exactly what they are after.
TER: Charles, thank you very much for your time today.
CN: Thank you.
In May 2009, Charles Neivert joined investment bank Dahlman Rose & Company LLC as managing director to head the firm’s new Agriculture and Chemicals Research division. Prior to Dahlman, Charles was an executive director at Morgan Stanley where he re-launched the firm’s commodity, specialty and fertilizer chemical equity research practice. He was also co-founder and president of New Vernon Associates, an equity research boutique specializing in global chemicals, which was awarded Institutional Investor’s “Best of the Boutiques and Regionals—Commodity Chemicals” honor for nine consecutive years. At New Vernon, Charles conducted all fundamental industry research on a global level, including analysis and forecasting of 50 distinct chemicals. He earned his Bachelor of Arts degrees in chemistry and economics from the University of Pennsylvania.
By The Energy Report, on August 19th, 2011
 Rising corn production acreage highlighted in the latest USDA crop report could lead to increased fertilizer demand and prices, says Richard Kelertas, a senior analyst at Dundee Securities. In this exclusive interview with The Energy Report, he points to which potash juniors could hit the market while demand is still high.
The Energy Report: U.S. corn production is up 4% from last year, according to a new Crop Production Report released this month by the National Agricultural Statistics Service. The August 11 report forecast a 12.9 billion bushel harvest. “If realized, this will be the third largest production total on record for the United States,” the report stated. Will this result in an increase in domestic demand and prices for fertilizer, particularly potash?
Richard Kelertas: Yes. We expect a gradual, but steady increase in crop and fertilizer prices going forward.
TER: Last May you predicted potash prices of $750/ton. When might that occur and what countries are the main drivers for this?
RK: A peak could come anywhere from 18–24 months from now. Our thoughts are as follows: We are seeing very tight potash markets. The Chinese have been asking for more. The Indians have now settled a contract for significantly higher than what they wanted to pay. Farmers have been pressuring the government to make sure there is plenty of fertilizer—especially potash and urea—in the fields, but they also want to make sure it’s at a half-decent price.
The supply is now getting out to the fields, but the price has gone up simply because there is a bit of a monopoly, with the major producers represented by Canpotex Ltd. Our view is that the price pressure will continue for the next 12–24 months. No major new capacity additions—brownfield or greenfield—are planned for the next two to three years. Really, the new capacity doesn’t kick in until 2014–2015. So 2011, 2012 and 2013 are going to be very tight markets. That’s on the fertilizer side.
On the food side, we have stock:use ratios that are very low. Crop prices are starting to recover although the second economic crisis we are going through now may cause those prices to ease off a little bit. Some crop harvests are going to be low throughout the world. The stocks of various staples will be tight for the next one to two years. So we think this is a perfect storm for fertilizer prices to continue to run up. It won’t reach the level of the last run up in 2008–2009, but it is certainly a very buoyant market.
TER: What impact do short-term stock fluctuations and economic challenges have on both food prices and fertilizer prices? What about the prospect of a weaker dollar?
RK: As you’ve seen in the past, it has had a short-term impact. If the fundamentals were weak to begin with—meaning crop stocks were high, harvests were very, very good throughout the world and inventories of nutrients were either at their 5–10 year averages or above—then you saw a significant downturn in nutrient and crop pricing along with usage. Farmers back off if crop prices aren’t high enough because they won’t get enough per-acre to justify putting in more nutrients. Plus, the bounce back in 2009–2010 and the beginning of 2011 was because of both strong fundamentals for fertilizers and crops and a tremendous amount of stimulus from governments that were pumped into the market. It remains to be seen whether governments still have those arrows in their quivers. I would suspect that this is going to be a little more drawn out.
Several governments are near crisis situations. The European Central Bank has said it will buy Spanish and Italian bonds; that will certainly help for the time being. The real question is: Are international consumers going to back off on buying feedstuff for cattle, poultry and their own diets? Will the middle class throughout the world continue to demand better nutrition? If that’s the case, even with an economic crisis, you will still see crop prices hold up fairly well. If everyone goes into a cocoon and cuts back on everything, then we could see prices fall back and the recovery will be that much longer. So it does have an impact. In this particular case, we think it is going to be short lived. We think it is going to be a couple of months where everyone steps back and commodity prices generally step back along with that. Nutrients and fertilizers are like any other commodity. They react to the individual fear factors going on in world markets.
As the U.S. dollar continues to weaken over time compared to other major currencies, potash prices in U.S. dollar terms will strengthen alongside the strong fundamentals.
TER: You mentioned some new capacity that might be coming on in 2015. Where is that and what companies are going to be behind it?
RK: PotashCorp (TSX:POT; NYSE:POT; Not Rated*) and Agrium Inc. (NYSE:AGU; Buy Rated) have some new plants. Those are brownfields. We also have the possibility of a couple of larger mines. Allana Potash (TSX.V:AAA; OTCQX:ALLRF; Buy Rated), for instance, may have its open-pit mine in Ethiopia up and running in early 2014. You will probably see only 300–500 thousand tons of potash come out of that operation in 2014, and it probably won’t be fully ramped up for 1 million tons (Mts.) until 2015–2016. We may have some more brownfield projects, but if they are deep shaft, those are going to take a heck of a long time. So, the most we are going to see is probably 2–3 Mts. with some brownfield plant expansions coming on by 2014–2015. Allana, which would probably be the first greenfield operation to come on-line, could be producing by sometime in 2014.
TER: Are fertilizer company stock prices going up along with food prices?
RK: No, they haven’t. Q211 results for most of the major players—The Mosaic Co. (NYSE:MOS; Not Rated), PotashCorp and Agrium—showed a bit of a perk up, but just as some real traction was starting to develop again, the debt ceiling issue put a stop to all upward momentum. Then we had the debt downgrade. That is going to put us on ice for the time being. Stock prices for all commodities will be off. If the U.S. dollar weakens enough, which we think it probably will over the next several weeks, then you may get a pickup in commodity prices as international buyers find it cheaper to come into the marketplace and any commodity priced in U.S. dollars tends to perk up. The light at the end of the tunnel could be negotiations with the European banks and U.S tax and spending reform.
TER: Let’s talk about what companies are going to be in a good position to capitalize on global demand when stock prices do come back.
RK: There will be, we believe, another run up going into 2012–2013 on stock prices. A prevailing fear factor will position well-established producers as the first ones to benefit when the market recovers. So Agrium, Potash, Mosaic—those are the key ones along with CF Industries Holdings Inc. (NYSE:CF; Not Rated) and Terra Nitrogen Corp. (NYSE:TNH; Not Rated). Those are the companies that have been around, have established solid earnings growth, have upped their guidance for 2011–2012 and have the volume and the staying power in this particular market. They have clean balance sheets, are well run and have some new capacity in brownfield tonnage coming into 2013–2014. So they are in good shape. Those are the ones we think will recover first.
The juniors will follow if there is a sustained market recovery. That includes Allana, PotashCorp, Karnalyte Resources Inc. (TSX:KRN; Not Rated), Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF; Watchlist Buy Rated) and IC Potash Corp. (TSX.V:ICP; OTCQX:ICPTF; Not Rated). We could see Ethiopian Potash (TSX.V:FED TSX.V:FED.WT; Not Rated) and Encanto Potash Corp. (TSX.V:EPO; Not Rated) move as well. It all depends, however, on how far along these companies are in their development and the results of either updated resource reports or first-time NI 43-101s.
These things will all depend on how strong the potash market has remained even though the stock market has fallen off. So in the next three to six months, if the economy is actually in the dumps and all these potash prices have come off, then these juniors will basically go nowhere. Farmers are a pretty fickle bunch. If they smell that there is going to be any weakness in the overall economy or in crop prices and their returns, they will step back. And they can step back fairly quickly.
If, on the other hand, potash prices hold up at the $474.90/ton price recently signed by the Indians, then you are going to see these juniors perk up. As it stands right now, the fundamentals are still extremely strong—they haven’t deteriorated at all. Demand is high worldwide for crops, the stock:use ratios are very low and farmers have lots of money in their pockets. They are feeling pretty good about the next harvest. This is important because right now they are making decisions about the spring plant for next year. We expect crop prices to be very good and that application rates will actually be higher in 2012 because farmers are planting more and trying to bring back drought and floodplain areas with extra fertilizer applications where nutrients have been washed out of the soil.
TER: You mentioned some of the catalysts that would be necessary for the junior stocks to start appreciating. Do you want to go through a few of those, starting with Allana?
RK: We expect Allana to go ahead with its plan to get an open-pit operation in Ethiopia up and running by 2014. Additionally, Allana could be a takeover target for the Indian government, which is still bristling about signing a higher-priced contract for 2011 and 2012 delivery. Along with the Chinese government, the Indians have been very active in Ethiopia, delivering foodstuffs to drought victims and committing $300 million to a major railway infrastructure project. They may be looking to sign either long-term contracts or purchase a producer or an up-and-coming junior to deliver 2–3 Mts./year reliably. That makes a lot of sense long term. So, it is quite possible that someone like Allana or Ethiopian Potash—although it doesn’t even have drills in the ground yet—may have several suitors come calling. That is one catalyst.
We also believe Allana is talking to several banks to act as a project finance lead bank. When that is announced and the market sees that Allana is serious about going forward with production plans in 2014, we think that will perk up the stock. That is catalyst number two.
Catalyst number three will be the updated resource report coming out toward the end of the year and the bankable feasibility report coming out in February or March of 2012. That will show quite clearly the low open pit mining and extraction costs predicted. We believe it will be the lowest-cost operation and the first to production in the world. Once that becomes clear, it will be a catalyst for the stock price. So we have three events coming up in addition to the extra drilling in the Danakil Depression deposit. Those will be smaller catalysts that continue to show 25%+ potassium chloride (KCI) at very shallow depths and significant thicknesses.
TER: Another one you mentioned was Karnalyte?
RK: It is a solution-mine potential operation in Saskatchewan so you don’t have any of the country or transportation risks that you might have in Ethiopia. Investors who want to stick close to home during an uncertain market might like Karnalyte. It is a contiguous, large-scale deposit. There could be anywhere from 2–3 Bts. of potash there. The company has come out with its NI 43-101 and an updated resource report will be out at the end of the year. It believes it can get up to 3 Mts. in the next five years quite easily. This would be a solution mine with high capital costs to start up, but it is not a deep-shaft mine, which is five to six times the cost. It will be very low extraction costs, $100–$120/ton delivered to British Columbia seaports. The added benefit here is the extent of the magnesium-oxide deposits along with the KCl. Magnesium oxide is used for many applications, including as liners for arc furnaces in steel manufacturing. Manufacturers are willing to pay more for secure, zero-boron content magnesium oxide. That is another revenue stream that has not been factored in by the markets. The company has hired a specialist in magnesium oxide extraction and end-use processing to capitalize on that opportunity. It will issue a report in the next six months on the conclusions. That could be the catalyst that drives Karnalyte to new heights.
TER: Very impressive. How about Passport Potash?
RK: Passport is coming out with its NI 43-101 in September, so that will be the first catalyst. It is not as great a deposit as Allana or Karnalyte, but it is located right smack dab in the middle of Arizona with all the infrastructure in place—road, rail, power and water; it has everything there. There are no environmental issues to deal with and all state, federal and local governments, including the Native American community, are on the company’s side. They all want this thing to be developed. The area is economically depressed and this project will employ 300–400 full- and part-time workers. So the catalyst here is the NI 43-101, that is number one. Number two is that the deposit could be big, although with not as high a KCl content as Karnalyte and extraction costs may be a little bit higher as well. To get the concentration of KCl that it needs to produce a good, modern organic product, it is probably going to have to extract more slurry than some of the other producers. However, this deposit could be 2–2.5 Bts. and there are other interested parties. A large oil company just to the south of Passport Potash’s concessions is looking to diversify its product mix. So it is quite possible that we could see Passport Potash have a suitor or two come calling.
TER: Interesting. IC Potash?
RK: IC Potash has a very interesting story. It is a little bit further behind everyone else in terms of getting its project up and running. We will probably have more information for you in the next call.
TER: The last one you mentioned was Encanto?
RK: Encanto is, again, in Saskatchewan. It has all the native groups on its side. It has a substantial resource, but will come online later than some of the others. We don’t expect it to be up and running until 2015–2016. It is a solution mine with a good management team and a fairly contiguous deposit. We wouldn’t rank it at the top of our list. Allana is No. 1, Karnalyte No. 2, Passport No. 3. Encanto is in the middle third of the juniors we watch.
TER: Anything else that our readers should be watching out for in the potash space in the next six months?
RK: I think you will find that there is going to be a race to get things up and running as quickly as possible. The savvy investor should get into the space now. By 2015–2016, you will have a lot of projects, and if any of these juniors come online, which two or three of them certainly will, you are going to have enough potash coming on market to supply all demand through 2017–2018. That could lead to a pullback in these stocks from 2014–2015. So you have two-and-a-half years of good market returns coming. To take advantage of that window, get involved with potash players that are established—Agrium, PotashCorp. or Mosaic, and Agrium is our favorite of those three. But also play the select juniors that have a good chance of getting up-and-running with a better-than-even chance of getting linked up in a large offtake agreement or having a suitor come calling. Those would be Allana, Karnalyte and Passport Potash.
TER: Thank you so much for your time today. It has been very enlightening.
RK: Thank you.
*Dundee Securities rating
Richard Kelertas has 25 years experience as a research analyst covering the forest products sector. He has been one of the top-ranked analysts in the sector over the years consistently, and was most recently ranked No. 1 by Brendan Woods. Richard has worked for a number of well-known brokerage firms, including ScotiaMcLeod, Deutsche Morgan Grenfell, UBS Warburg, and Desjardins Securities. He has a bachelor’s degree in forestry and a master’s degree in forestry and economics from the University of Toronto. Richard is also a Registered Professional Forester.
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By The Energy Report, on June 26th, 2011
 Domestic demand for fertilizer is good news for small, U.S. potash producers. In this exclusive interview with The Energy Report, Weiss Research Natural Resources Analyst Sean Brodrick explains the international market forces behind agriculture-related stocks and points to the companies that could benefit in the long term.
The Energy Report: I understand you’re not really bullish on energy these days. Can you give me a brief synopsis as to why?
Sean Brodrick: I’m concerned about the perception of a slowdown in the global economy. With so much free money floating around the market, the psychology becomes so much more important. And, right now, people are really worried about a slowdown in the global economy. They’re starting to pull back and retrench.
Recently, we saw a rally in the market that could go on for a while because things have gotten so oversold to the downside. But the fundamentals haven’t changed. We are seeing fewer government financial injections, thus taking away the punch bowl. That weighs on energy stocks and a recovery generally. Also, we’re seeing worrisome news out of China. The country is still using a lot of energy—more each year. But, the demand for copper is falling off quite a bit. In fact, the most recent numbers I saw said that last month we saw Chinese copper demand drop off 47% year-over-year. May was down 6% from April, which was another down month. Copper is often an indicator of the global economy. Now, the Chinese just might be messing with us as they often do because they like to manipulate the market to get cheaper prices, but it also could indicate a global slowdown. If that is the case, then energy prices usually follow. So, we could see lower energy prices for some time.
You and I know that these energy companies make fantastic money even when oil is over $85/barrel. They make great money. But, again, it’s the perception, the psychology. People worry about quarter-over-quarter comparisons. They tend to punish stocks—perhaps a little unjustly, but they punish them anyway. So, we could see more downside in the broad energy sector.
TER: However, I understand you are very bullish on the potash market these days. Why is that?
SB: Short-term perceptions and worries about a global slowdown aside, the long-term reality is that we have 70 million people in China who are joining the middle class every year. We have millions more in places like India and Malaysia. All these people want to eat and live like big, fat Americans. So, the agricultural producers of those regions are hard-pressed to keep up with that demand. In fact, global consumption of things like grains, nuts and seeds—everything except meat—has gone up 2.5 times since 1970 and it keeps accelerating. This is driving the demand for potash, which has gone up something like 5.6% for the last three years in a row. It doesn’t seem like it’s really going to slow down. Now, if we saw a major downturn in the global economy, we would have to worry about that. But until we do, we’re going to see increasing global potash demand because farmers need it to increase their yields. The green revolution sent agriculture yields much, much higher. Now you have to put in a lot more fertilizer just to get incrementally larger yields. The only way you’re going to get those grain yields is by using potash.
Only 12 countries actually produce potash. Canada, Russia, Bellerose and Germany account for more than 75% of the global supply. And only eight companies control 80% the world’s potash production. Do you see how this could lead to a price squeeze? China will probably try to lock in potash supply going forward because of its need to feed its people. As China starts hoarding international potash supplies, we will have to look for domestic sources. That is good news for new, small potash producers in the U.S, which is already an agricultural powerhouse. We are to grain what OPEC is to oil. Increased U.S. demand for potash could certainly make a difference in the share prices of these small companies as long as they can continue to go into production and/or increase production.
TER: The U.S. gets most of its potash from Canada today, correct? What are the small players in the U.S. you like right now? Can they completely fill the domestic potash demand? Where do you see that market going?
SB: Right. Well, I like Intrepid Potash Inc. (NYSE:IPI) in New Mexico. This company seems to be doing things right. This is an example of a stock being punished unjustly. It has been brought down with the rest of the broad market. The correction in the broad stock indexes compressed the price of Intrepid Potash even as the company increased production.
Another one I like is Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF), which you and I visited. It is a developer in Arizona with a great project near the American heartland. The company is doing more drilling, moving it along. I think the dominos are lining up. Passport is moving down the path to production of a million tons a year. This company is in a good position to do pretty well, but it has to get into production first.
TER: Passport Potash announced some initial drill results recently.
SB: Yes, they did and boy, they were good. Preliminary results from two core holes showed significant potash deposits at relatively shallow depths. The company intersected 9.5 feet of 12.29% KCL. Some parts were actually richer. More results should be coming in over the summer. As they report those, maybe the market will take a second look. Because of the risk of not being in production yet, Passport has really been punished along with the broader market. But the payoff could be much higher, especially if the company attracts the attention of one of the big boys, which I believe is going to happen down the road. Then I think Passport could do very well. We could see this thing jump quite nicely. Remember, Passport won’t be ripping up a huge hole in the desert with big trucks. This is planned as an in-situ leaching project. Passport will pump solution in one side of the field through the potash deposit and filter it out the other side. So, you don’t move a lot of dirt. That makes it easier to get environmental approvals.
TER: There has been some talk about the possible end of the ethanol subsidy affecting the broader fertilizer industry in the U.S. Do you think that is significant?
SB: It is significant in that it affects market psychology. The market mentality impacts all kinds of stocks. There was some action in the corn markets that you would not believe. However, let’s face it, 2012 is an election year. Do you want to be the political party that takes away the ethanol subsidy when you’re going into the Iowa caucuses? You could argue about whether subsidies are a good thing or not, but I just don’t think it’s politically feasible to take it away. I don’t think it’s actually going to happen. It’s all politics in ethanol.
TER: I hear even Al Gore is now saying that it was a mistake to suggest that ethanol could be a significant alternative energy source.
SB: Right. But that subsidy is probably not going away. It looks like an easy target, but when you take political considerations into account, and you have to, then it’s not a target you’re going to hit. Ethanol subsidies will be in place at least through the 2012 elections.
TER: Thank you very much Sean.
SB: Sure.
A natural resources analyst for Weiss Research, Inc., Sean Brodrick travels far and wide seeking out investment values, primarily among the small-cap and micro-cap players. He edits Weiss Research’s Crisis Profit Hunter and Red-Hot Global Resources, as well as making regular contributions to Uncommon Wisdom Daily. He is also a contributing columnist to Dow Jones MarketWatch and a frequent commentator on one of Canada’s premiere financial websites, HoweStreet.com. Sean’s expertise has led to many financial talk show appearances, including CNBC Squawk Box, Fox Business, CNN, The Glenn Beck Program, Your World with Neil Cavuto and Bloomberg Market Line. He is the author of The Ultimate Suburban Survivalist Guide, a guide to surviving the ever-changing economic landscape from stock market shakeups to oil and currency crises to natural disasters. A graduate of the University of Maine, Sean has more than 25 years experience as a professional journalist and financial analyst, including a stint as investment director of the Sovereign Society—the world’s leading publisher of offshore asset protection strategies and global investment opportunities.
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