Investing in a Resource-Constrained World (Part IV)

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 |  Includes: ACIIQ, AGU, APD, BSC, BTUUQ, BUCY, CNX, FSLR, IPI, JRCCQ, MEE, MOS, NILSY, PAL, POT, SWC, TRA
by: Mark Anthony

Originally published on author's blog on April 12.

Recent developments in the general market make it necessary for me to continue this serial article about investing in a resource constrained world. I will be talking about food, agriculture and energy related investment topics this time.

In the part three article, I debunked Mr. Epstein's commodity bubble burst theory. The market quickly proved me right in a strong return of the commodity bull. Oil price jumped to record breaking $118 a barrel. Retail gasoline price now almost $4 a gallon. Food prices worldwide, leading by rice, rocket up and there's panic buying and hoarding of rice and other essential food all over the world. I bought 10 bags of rice three weeks ago before they were all gone. My rice bags made it into national headline news, thanks to Mr. Josh Gerstein. It wasn't a matter of me trying to save a few bucks. It's a matter of availability. Folks holding FSLR stocks tried to argue with me that tellurium is still quite affordable to FSLR. They do not understand it's a matter of availability, not affordability. Why don't folks contact FSLR and demand a specific and quantitative answer on their tellurium supply?

The availability vs. affordability debate will always bring up a very unpleasant topic that must be told, Demand Destruction, and an even more unpleasant but absolutely true topic, Malthusian Catastrophe on population growth. I will talk about it in more details in later articles.

We are entering a phase of severe global economic recession, triggered by the global credit crisis. Normally an economic recession means reduced demand on commodities. But it's different this time. I mentioned that for the first time, we are hitting the natural limit of supply on many non-renewable natural resources. The current crisis is caused not just due to imbalance in the economy, but also due to depletion of natural resources like petroleum, precious metals and base metals. If you are unfamiliar with the topic of Peak Oil, I advise you to buy a copy of Twilight in the Desert and visit TheOilDrum.com. In simple language, when exactly half of a non-renewable natural resource has been consumed, trying to produce the remaining half becomes every increasingly difficult and the annual production will be ever declining, until it's all gone.

Not only oil has peaked, a lot of other natural resources have peaked, or will be peaking soon. Those include helium, which has peaked long ago. You might consider APD for helium play. Copper has peaked and there is only 27 years worth of identified copper reserves left. Nickel has peaked as well. Silver production has long peaked and now there is only 13 years worth of silver left to be mined, based on USGS data.

The PGM (platinum group metals), on the other hand, is no where near peak yet. But I happen to believe the PGM will be the best natural resource play in short and long term, due to rapidly expanding usages and price inelastic nature of both supply and demand. That's why I like the only two primary palladium mining company in the whole world, PAL and SWC, as my most favorite stocks. Please read VM Group's recent research paper on PGM metals.

I have now heavily invested my 401K account into just two stocks, mainly PAL, and then some SWC, as price of both have dropped to a very attractive level, and all the bullish factors remain intact. The South African electricity crisis is becoming worse as they approach winter now, greatly impacting PGM metals production. Not only regularly scheduled load shedding is carried out daily, but ESKOM now stopped releasing info on power alert indicator or the total amount of load shedding, probably for fear of disclosing bad news. Auto sales in China grows at 25% or higher pace, now reaching 10.32 million per annum while the sale in the US only dropped 0.4%. That's a great boost of auto catalyst demand on PGM metals. Year 2008 is a huge Chinese wedding year and lots of ladies will purchase platinum or palladium diamond wedding rings.

I don't understand why people sell off platinum and palladium, knowing there is an industry deficit for both metals. Why should the stock of PAL be pushed to near multi-year low, while the metal prices are near multi-year highs? Dirt cheap stock price of a company of bullish outlook is an excellent buying opportunity. Insiders of PAL, North American Palladium, are buying shares of their own company from open market, according to recent filings found on SEDI.CA. At a time when most company insiders are selling their stocks like crazy, it's refreshing to see PAL insiders buying from the open market with their own money.

Most market participants are incapable of doing quality due diligence research and can only blindly chase stock price momentums, at the end of day the mobs always lose and savvy investors who stick to fundamentals win big time. At this time I do not even own FSLR short positions and have nothing to gain if FSLR suddenly collapses tomorrow. But I must insist on telling the truth of my research on the global tellurium shortage. If you hold FSLR, it's in your own interest to do your own research to find out what's going on, or at least push for FSLR to reveal quantitative information on their tellurium supply and usage. I believe that insisting on objective discussions of facts and logic helps return the market to a healthy state where companies are more fairly priced to their real valuation, instead of being rigged by professional market manipulators on the Wall Street. Do we need more ENRONs or BSCs?

Now return to commodities. Oddly, none of the best performing commodities in recent times are near any geological peak. Food, of course, leads all commodities in recent rally, as well as fertilizers. Price of coal skyrocketed, although the world still has plenty of coal left. Thanks to the coal price rally, stocks like ACI, BTU, BUCY, CNX, JRCC and MEE boomed. JRCC rallied from $4, where I purchased some, to a recent high of $25.37. When I purchased JRCC I figured that coal price may soon start to go up and JRCC may start to turn profitable. It is my belief that when a company goes from not profitable to profitable, the stock price appreciates fastest during the transition period. I figured that JRCC could go to $40 and it would take three years to get there. But the strong coal rally took me by a big surprise. I sold JRCC way too early and was never able to buy JRCC back. A lost opportunity and lesson learned that when you locked onto a bullish stock, you should never be swayed into selling by some temporary corrections.

Related to the global food shortage and food price rally, agriculture stocks are also on fire. Particularly in the fertilizer sector, we see some incredible rally in stocks like POT, MOS, AGU. The rally do seems to be justified, as the global fertilizer prices skyrocketed. What is worth noting is POT, which is the the largest potash fertilizer producer in the world, at about 9 million tons per year production scale.

How high will the rice and other grain prices go? How high can prices of fertilizers like potash go? Even though my 10 bags rice hoarding went on national news, my opinion is the boom and burst cycle of food grain will be relatively short, as proven time and again by history. A great famine is always followed by a great harvest. Oddly, historic records rarely show skyhigh food prices during famines. The reason is food prices are very price elastic. Most foods are consumed by poor people, the majority of the global population. They have no choice but cut back in face of higher prices, because they have limited money to spend. Instead of paying more, which they can't, they buy less, eat something else more affordable, or worse, die off due to hungry and malnutrition. Demand destruction at its cruelest. The population thus is reduced to the level where the available food can sustain. If a global natural disaster destroys half of the world's harvest in one year, then the poorest half of the world's 6 billion population will die off. Next year a good harvest may bring the food production back to normal level but there is no longer 6 billion mouths to feed, and food prices may collapse.

Some argue that as living standard of China and India improves, people eat more meat, hence mandating more food consumption to feed the animals and hence food price must continue to go higher. But food grains are merely taken away from the mouths of the poorest people in order to feed the animals. Wealthy people always eat meat and poor people never have enough to eat. The world is never fair to begin with.

Food is both perishable and completely renewable. The world will never run out of food. The next harvest is always less than 6 months away. So the grain bull market can not last for much more than a year or so. The food price can not go up indefinitely, either. When the food prices exceed the level where the poorest people can afford, they stop going up further. Rich people have money but they only have one stomach. So although I agree with Jim Rogers who predicts many more years of commodity bull market despite of the coming recession, I disagree with his emphasis on agriculture as the most bullish of all commodities.

Relating to the booming food prices, is the booming fertilizer prices. Players in this sector includes POT, MOS, AGU, TRA and a recent IPI. What is particular worth noting is POT, Potash Corporation of Saskatchew, No. 1 of the world in potash fertilizers, No. 2 in nitrate and No. 3 in phosphorite. The skyrocketing stock price of POT is mainly due to skyrocketing potash price. As recent as in year 2002 potash price was as low as $75 per short ton, now the news just break that the Chinese are paying $355 per ton more, raising from last year's $270 to now $625 per metric ton, for a total of 0.75 million metric tons worth of potash. More recent news says $1000 per ton is possible for the second half of the year. Such stunning news of course pushed POT share price to all time high of $216. Michael Pentothere is no bubble here in POT.

I beg to opine differently. When every one is talking about fertilizers and what a great company POT is, it's already too late for late comers and there might be a bubble forming. The world's population has been growing and has been eating for decades. Artificial fertilizers have been used for many decades. Potash supply, demand and price has been flat for three decades. So what has been changed in recent three years? A flooded mine in Russia last year and POT took the monopoly advantage and suspended sale, causing panic amongst the unprepared fertilizer buyers in the third world countries. The global potash market is tightly controled by two entities, Canpotex and BPC, leaving the major fertilizer buyers of China, India and Brazil no bargaining power at all. It's a good lesson learned that major countries like China and India MUST establish national strategic stockpile of fertilizers worth at least 3 years consumption. It is not just a matter of food security, but gives these countries greater bargaining power. I notice that POT has 13.25 million tons9 million tons. This looks like they use their monopoly power to limit supply and price gauge the global potash market.

I think POT is abusing its dominance power for the short term gain, but will hurt itself in the long term, like killing a hen to retrieve all the eggs at once. Natural plantations grow without potash fertilizer, because dead plants decompose on the spot, releasing potash back to the soil. Traditional agriculture removes only a very small eatable portion of the grain plantations, and return the bulk of the plant bodies to the fields, after decomposition or burning as cooking fuel. So the fields remain fertile. In recent years, Chinese farmers abandoned the traditional methods in favor of the easier potash fertilizer, due to increased income and affordability. Excessive application of fertilizers do not always result in the expected result, as potash is quite solveable in water. Rain water washes off the excessive amount of fertilizers, polluting major rivers. Will the Chinese farmers return to more sustainable traditional husbandry methods, in face of skyrocketing potash.

The earth is plentiful in the potassium element. But rich, cheaply produceable potash resources concentrate in only a handful spots. At today's high potash price, many previous uneconomical potash resources all over the world can now be produced profitably. Many countries, including China, has been producing potash fertilizers from salty lakes. For decades, Israel and Jordan are producing a combined 3.77 million tons of potash from the Dead Sea, which is only 8 times saltier than the ocean. All of the salty lakes of the world provide great opportunities to expand potash production. If the price remain even at half of today's price, I don't see why can't any one start to produce potash from the ocean itself. I see a potash price bubble.

POT, a company which has limited room to increase either the production, or the unit price, currently at a high P/E reserved only for companies perceived to have unlimited growth potential, is a clearly over-priced bubble. I would NOT short it here yet because I know the giant inertia force of group mentality of investors. But watch closely for an opportunity to short after the harvest season.

Watch JRCC and other coal mining company for opportunities to buy on the dip, as coal price is still cheap and has some more room to go up. But I believe the PGM metals, my favorite, has way much bigger room for price gain. Just look at rhodium. Went up from $300 to $9000 per ounce in 4 short years. Is this a peak already? Hardly! That's what a commodity of extreme price inelasticity can do.

PGM metals are extremely price inelastic, because few places in the world produce these metals. Russia's Norilsk mine has been produced for decades and now is in steep decline. Largest PGM producer, South Africa, is crippled by a destructive electricity crisis. It can't even maintain current production, let alone expand capacity in the next few years. Outside Russia and South Africa, SWC and PAL are the only primary PGM metals producers. That's the price inelasticity on the supply side. On the demand side, the PGM demand in various applications are booming: auto catalyst; catalyst for oil refinery, chemical industry and fertilizer production; electronic application in MLCC (multi-layer ceramic capacitor), which see one trillion annual production and growing, and in LCD big screen TVs, etc.; Palladium dental fillings; palladium food inserts for preservation; fuel cell applications, etc. etc. PGM metals must be used in all these industries, there is virtually no replacement available, and quantity used per unit of product is usually small so the cost is not a big factor.

Take the dominant PGM metal usage, auto catalyst, for example. Some believe an economic recession may reduce automobile demand and hence auto-catalyst demand. But according to this article, China's auto sale is growing at 21% or higher annual growth rate and now reaches 10.32 million catalyst converter thefts, leading to increased demand on replacements.

Vehicles must have catalyst converters that comply to tightening environmental control regulations, for good reasons. Global air pollution causes more than 4 million unnatural deaths per year, far more than traffic accident deaths. Without catalyst converters reducing the air pollution, the air pollution related deaths could triple to 12 million per year. So the annual consumption of 8 million ounces of platinum and palladium in auto catalyst applications saved 8 million lives a year. One life saved per ounce of metal. How much is one human life worth? How much is once ounce of platinum or palladium worth? No wonder the 2007 Nobel Chemistry Prize was awarded to the work that leaded to the invention of PGM based auto catalyst converters. The scientist have saved a population several times the total deaths of WW II. I am humbled to say that is the most deserving Nobel Prize awarded to a noble research work on the noble metals.

Unlike food, which every one eats, rich or poor, automobiles are only for those wealthy enough to afford them. And unlike fertilizers, for which plants can grow with less or with alternatives, PGM metal usage in auto catalyst converters can not be reduced. Decades of research have already exhausted most thrifting opportunities. Tightening environment regulations probably mean more metals need to be used in order to improve efficiency. It's ridiculous for some industry insiders to spread unsubstantiated technology news, making claims like silver based catalyst converters replacing PGM metals. We all know silver readily reacts with sulphur dioxide in the exhaust gas, rendering it useless. People who can afford to buy a car surely can afford to pay for a few extra grams of noble PGM metals, for the noble cause of save some human lives from air pollution. We are supposed to believe that silver catalyst converters will go into commercial usage in 2012. By that time, every one will have forgotten the story.

With such bullish outlook of the PGM metals price, how could I not get heavily invested in the only two PGM metals players in North America, PAL and SWC? Especially at such ridiculous low prices. I see nothing better to buy. I am a firm believer of Warren Buffett philosophy. He said if you really know what you are buying, there is no need for diversification.

Disclosure: The author is heavily invested in PAL and SWC at the time of writing.