Palm Oil: The Investment Thesis

It is no secret that crude oil has been falling hard lately, but a less known fact is that another commodity has fallen with it. Palm oil has been hit hard together with the decline in crude oil prices (see chart below created by Correlation Economics). The correlation between palm oil and crude oil is not so apparent before 2007. It was only when the biodiesel and ethanol industry became important after 2007 that we began to see the emergence of this correlation. When you look closely, the palm oil price moves first, while the crude oil price moves several months later. This can be an important tool for investors to predict what’s going to happen with the crude oil price (OIL). But let’s focus on palm oil here.

Read the entire analysis here.

Has agriculture found a bottom?

The latest interview with Marc Faber (Barron’s) sparked an idea with me. In that interview he said that palm oil was going to do well. The palm oil price is very much correlated with the soybean price and we are seeing a rebound in soybeans at this moment, while palm oil hasn’t seen a rebound yet. As a Belgian, the best way for me to invest in this idea is to buy shares of Sipef (SIP). These profitable companies will pay dividends of 2%-4%, way higher than what you get in European bonds and cash.

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Currently, the low crude oil price has dragged the palm oil business down with it. Why you say? It’s all because of the derivatives complex. But we are seeing price reversals in agriculture at this moment. For example, when we look at the overall agriculture commodity index RJA, it is showing a bottom.

Also, potash prices are finally on the rise. We have seen the first uptick move in over more than 3 years and potash companies have seen rebounds as well. So, plenty ideas for your next investment!

Arbitrage opportunity in agriculture

At this moment there is an interesting arbitrage opportunity for investors in the agricultural space.

When we look at the potash price we see the following trend downwards. Ever since the break-up of the potash cartel between Uralkali and Belarusian Potash Company in July 2013, we have seen a drop in potash price from 400 USD/t to 300 USD/t (see chart below from InfoMine.com).

Normally, the potash price follows the food price, because the food price is a leading indicator for the potash price. I have noted this correlation here. So you would expect that the potash price would get some momentum upwards since food prices have soared almost 20% since the start of 2014 (see chart of RJA below from Google Finance, which represents agricultural prices).

To read further, go here.

Rising Food Prices Pushing Up Potash Stocks

Agriculture prices have been going up since the beginning of 2014 and I think that if this trend continues, we will see demand going up for potash, which is used for agriculture.
The chart below monitors the food prices. You can see the recent surge in 2014. Many foods went up like coffee, sugar, even wheat.

RJA agriculture

If we chart the agriculture index RJA against the largest potash producer Potash Corp., then we get this.

Food (RJA) Vs. Potash (POT)

We see a correlation here between food prices and potash prices. Food prices are obviously a leading indicator for potash sales and as a consequence we can say that higher food prices will push up potash prices.

So if you want to bet on higher potash prices (because of the recent surge in food prices), then you should buy the potash companies like Yara International, Potash Corp. or Allana Potash.

Allana Potash Update

Just to document a video on Allana Potash, a stock I believe has upside potential.

Update on Allana Potash and Avino Silver & Gold

Two stocks I have been quietly accumulating on are Allana Potash and Avino Silver & Gold. I believe these two stocks are set to have a good run in the coming year.

Allana Potash, which I have been talking about here and Avino Silver & Gold, which I have been talking about here, both have catalysts.

1) Allana Potash just announced its first tranche of equity financing and more importantly an off-take agreement with ICL Potash to buy the entire production. Basically, ICL Potash has plans to buy about $80 million of the company with equity financing. Of course this will reduce the upside, but it will derisk the project and make the upside in share price more likely. We don’t know what the lending side is about yet, but I’m hoping it will be a good deal.

2) Avino Silver & Gold has doubled in value since December 2013 on very good production results. And we aren’t even counting in the new production that is coming online later this year with the Avino Mine itself. We also see insider buying in February 2014, so there is much more upside on this stock. And I’m not even counting in the surge in silver price which is sure to come.

Just my two cents…

Allana Potash Nearing Construction Financing

Following the news on July 30, 2013, that Russia’s OAO Uralkali was abandoning Belarusian Potash Co., a joint venture with rival Belaruskali of Belarus, the whole potash industry’s stock market fell around 20%. Two cartels, Canpotex (PotashCorp, Mosaic and Intrepid) and BPC (Uralkali and Belaruskali), which control 40% and 30% of the potash market, would split up into three cartels: Canpotex, Uralkali and Belaruskali.

Uralkali said it would be focusing on production volume, which means they would sell more potash following the breakup of the cartel. As a result the capacity will grow on this news. The question is, how should investors play this news? Should they buy the dip in potash stocks or sell out?

Today, a month after this news, we already see that potash prices have fallen 5% just recently. Prices for spot shipments of the crop nutrient from Port Metro Vancouver recently slipped $20 (U.S.) to less than $400 a tonne, while there are preliminary signs of market softness elsewhere, including slightly discounted potash prices on rail shipments to China. So, it looks like potash prices are indeed softening.

We know that demand is still growing as potash deliveries are dependent on population growth in the Asian world and that number is still growing at a rate of around 5% per annum. If we bring this number down to world population growth, we have a growth rate of 1.1% per annum. Demand for potash is pretty inelastic, so it could be that some years demand will be higher due to lower potash prices, while other years will have less demand due to high potash prices. Overall, the demand side looks positive. According to Green Markets, a fertilizer industry information provider, demand will increase 26% to 66 million tons. Now let’s look at the supply side.

Chart 1: Potash Delivery Vs. Population Growth

The potash industry is having a pretty high capacity utilization rate of around 80% (not as high as compared to a typical 90% capacity utilization rate in the mining industry), but let’s say there is overcapacity at the moment. As capacity is set to grow due to the breakup of the cartel, we could see falling potash prices. At this moment, the marginal cost of potash production is around $280/tonne. So we could see potash prices fall another 30% to this level due to an increase in supply. It is estimated that supply will go to 96.5 million metric tonnes by 2017, according to Green Markets.

A good metric to predict potash prices is to look at the capacity utilization trends. The capacity utilization rate is a leading indicator for future inflation. When capacity utilization goes up, we can expect a similer increase in price in about a year from now. We can use this theory to predict potash prices.

Chart 2 gives the potash capacity utilization projection. As you can see, the capacity utilization plunged from 90% in 2007 to 50% in 2009. This corresponded with a drop in potash price from $870/tonne in 2009 to $312/tonne in 2010, exactly a one year lag as predicted by this correlation between capacity utilization and prices.

If we then look at what is happening in 2013, we see that the capacity utilization rate is pretty flat, so I don’t expect any huge movements in price in the coming years, but prices could certainly soften to around marginal cost of production. If we look at the Green Market numbers, we would get 66 million tonnes and 96.5 million tonnes by 2017. That’s a capacity utilization of around 70%. This really isn’t all too bad, considering the plunge to 50% in 2009. Also consider that many of the mines won’t come into production at the current price of $400/tonne.

Chart 2: Potash Capacity Utilization

Chart 3: Potash Price (KCL)

The conclusion is that this breakup in the BPC cartel can definitely lower potash prices to around $300/tonne. If you know this will happen, you should invest only in those projects that are low cost. Many development projects need at least a $400/tonne potash price to be economically viable, according to Patricia Mohr, vice-president and commodity market specialist at Bank of Nova Scotia. Knowing that potash prices could go lower than this level, I would be very wary about development companies. Investors should look at low cost producers that are fully funded.

One of my favourite plays was Allana Potash (ALLRF.PK) and it is still my favourite. I have written about this company a year ago. Even though Allana Potash has declined since then (together with the whole commodity market and mining industry), the news gets better and better. Allana Potash’s valuations have only improved and the company has all the ingredients to make it into a producing mine.

Read about Allana Potash here.

Allana Potash: Update

Agriculture has been in a bear market since February 2011 as evidenced by the Rogers Commodity Index for Agriculture (RJA). But surprisingly, since June 2012 something interesting happened. We got a spike of 16% in the agriculture price due to supply concerns in the corn, soybean and wheat market (Chart 1). This spike is also felt in stocks like Potash Corp. of Saskatchewan (POT) and Mosaic Company (MOS). As agriculture prices increase, so will the fertilizer prices increase.

Chart 1: Rogers Commodity Index Agriculture (RJA)

Agriculture is one of the sectors I’m very bullish on and it’s not just me. Marc Faber’s recent outlook for agriculture has been very positive. Marc Faber expects more weakness in industrial commodities, though he said agricultural commodities “look better”.

In the past year, fertilizer developers have been decimated. One of these developers: Western Potash ( (WPSHF.PK ), had additional problems due to development doubts in their project due to market speculation that a deal with a potential Chinese investor in the company fell through. Another company, Ethiopian Potash (FED) has been on the brink of collapse due to its dire financial situation. And more recently, BHP has been exiting Ethiopia due to weak exploration results.

On the other hand, Allana Potash (ALLRF.PK), which I talked about in this article, had increasingly positive news over the past year. Though, the share price hasn’t increased yet (Chart 2).

I will give a quick update on Allana Potash in this article.