I love this quote.
Not because I’m a Donald Rumsfeld fan but because it’s so applicable to what investors face daily.
The knowns are easy… investors who take the time to read can find a slew of facts and data on public companies.
The unknowns are more challenging. How will fertilizer companies’ profits change for every 10% decline in farm income? That’s an unknown, sure, but you can make an educated estimate.
Then there are the “unknown unknowns,” as Rumsfeld put it. Those bits of market-moving information that come flying out of left field… that were never even on anyone’s radar.
Nassim Taleb called them “black swans.” And we’ve recently witnessed one…
Uralkali, a Russian fertilizer producer, delivered a blind-siding blow when it announced a sudden exit from the informal cartel of which it had been a member. This, of course, caught investors completely off guard. And it sent shockwaves through the universe of fertilizer stocks. Shares of major producers took a beating – some 10%, others 40% – in a matter of days.
The whole saga reads much like a conspiracy theory-laden crime novel… beginning with the obvious question: “Is there even a place for cartels in ‘free markets’?” and ending with accusations of insider trading. (Alexander Nesis sold his 5.1% stake in Uralkali just four days before the July 30 announcement.)
The facts, along with a healthy dose of speculative theories, are all over the newswires, so I won’t get into the details here. Instead, I’ll summarize the key points for any who have missed the story. Then, I’ll show you one way to potentially profit from the shake-up, regardless of what happens to potash prices.
First, the summary…
Basically, fertilizer producers banded together. The two big cartels are Canpotex Ltd. and the Belarus Potash Company. Three North American producers – Agrium (NYSE: AGU), Mosaic (NYSE: MOS), and Potash Corp. of Saskatchewan (NYSE: POT) – controlled the former. Uralkali and Belaruskali, in Russia and Belarus, controlled the latter.
Between the two cartels, these five companies essentially controlled the global fertilizer market. Their mission? Keep fertilizer prices as high as possible.
At that, they succeeded.
Between 2008 and 2009 the price of potash fertilizer spiked from $200 to $875 per metric ton. This made the cartel members very happy because they got to enjoy super fat profit margins, thanks to their agreement to act in concert.
The rest of us, the ones who’ve had to pay so much more for food because farmers needed to cover their higher fertilizer costs… we weren’t so happy.
But then, that’s how cartels work. At least until they don’t…
Offering little explanation, and even less warning, Uralkali sent out a press release on July 30, essentially saying “we’re going it alone.” It did this because, while it too benefitted from the high fertilizer prices, it was unfortunately hamstrung by the export limitations. The company’s exit from the Belaruskali cartel telegraphed its new strategy: higher sales volumes (despite likely lower potash prices).
Free from the cartel’s agreements, Uralkali is now able to sell as much fertilizer as it likes, to whomever it likes. The company is boosting production to 100% of its capacity and makes no bones about the likely impact on fertilizer prices. In fact, it’s now telling the world to expect at least a 25% drop in the going rate for potash.
I told you. It sounds like something out of a cheap paperback novel.
Reading story after story about Uralkali, one thing is clear to me: No one has a clue about what’s going on. Some think Uralkali is bluffing… that it will be “business as usual” soon. Others see potash prices losing 50% or more.
With so many unknowns in the equation, the safest bet is to sit on the sidelines. Just wait for the dust to settle.
But where’s the fun and profit in that?
Instead, while taking all necessary precautions, it is much better to identify possible opportunities now so you’re ready to jump on the train when the time comes. In this particular instance, look to Agrium, the Canadian “Wal-Mart of Fertilizer.”
I recommended Boom & Bust subscribers buy Agrium stock in February 2012. And the stock treated us well, handing us double-digit gains on two occasions. Today, with prices 25% off their January peak, the company looks attractive again.
Trouble is, it could be even cheaper in a month… because the biggest unknown in this equation is the future of potash prices. Will the commodity go back up to $800 a ton, like the good ol’ days, or fall below $300, as many expect?
A spread trade helps eliminate the risk of this unknown. If we buy stock in Agrium, and sell short another fertilizer producer, the net effect of any changes in the price of potash becomes a wash.
You see, in the new environment, where the price of potash is likely to be volatile, sales volumes will be king. That means, while all fertilizer producers will face a headwind of falling potash prices, the winner will be the company who can sell the most.
And my extensive research shows that Agrium has the leading edge on that score. The company has grown its total sales by 26% over the last five years. Competitors, like Potash Corp., have only managed sales growth of around just 9% during that time.
If you’re looking to take this industry shakeout as your opportunity to buy a fertilizer stock, here’s my recommendation:
1) Buy shares of Agrium (AGU).
2) Sell short shares of Potash Corp. (POT).
Simply invest the same dollar amount into each side of the trade. And, don’t forget to employ a risk-management strategy. Instead of setting stop-loss orders on both trades, simply track the net gain or loss of the two positions from week to week. Consider closing both positions, simultaneously, on a net loss of about 10%.
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