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Long PotashCorp, but with regret

|Includes:BCE, BHP, DIA, POT, RIO, SPDR S&P 500 Trust ETF (SPY), TU
North American stock markets are cutting through summer highs like a hot knife through butter.
Monday mornings are always driven by participant enthusiasm and we will wait until this afternoon, before confirming the bull market we have been talking about for four months now.
We first declared a bull market in the offing on the Business News Network, on May 31, with fertilizers and telecom being our sectors of choice. Boy, have they gone up!
Today, the September National Association of Homebuilders confidence index was released unchanged  which for a US housing indicator these days, is good news, the market rally barely hiccuped on the result.

US housing-related numbers are always expected to be bad; anything good, or even neutral, in tomorrow's August Building Permit and Housing Starts, would be bullish fodder.
The S&P 500 index (SPX)  is currently at 1,135.37 up 10 (last intraday high was 1,131 on June 21).
The DJIA (NYSEARCA:DIA) is at 10,699.5 up 91.7 (last intraday high was 10,719.94 set on August 9).
The NASDAQ Composite (COMP) is at 2,340 up 24 (last intraday high was 2,341.11 set June 21).
The S&P/TSX Composite is at 12,247 up 82 and breaking the mid May level of 12,210 with an impressive 778 point gain since August 25.
We’ve bought PotashCorp (NYSE:POT) today at prices ranging from $152.65 to 154.37 Cdn.
My attitude has always been, “if you can’t beat’em, join’em”, but in this case, I am changing my neutral posture on PotashCorp to bullish, but with regret.

Although regulatory hurdles remain to any foreign buy-out of PotashCorp, I believe the Chinese are especially motivated to buy into the leading potash organization with control, sanitizing the bid and making it politically palatable with the participation of a few well-meaning Canadian pension funds.
In my view, Canadian pension funds should be taking the lion’s share of any Sino-led bid for PotashCorp. I think allowing a big Chinese position in PotashCorp would be a mistake. It would lead to a reduction in Canadian potash prices, royalty and tax revenues and remove another large cap stock from the TSX.

The price of international potash has traditionally been set by negotiation between the Canadian potash export organization, Canpotex of which PotashCorp is the senior member, and the biggest buyer, traditionally China, which is forecast to be the biggest consumer of export potash going forward (with Brazil and India close behind).

How would price discovery/determination be realized if the buyer were a big part and controlling member of the seller? The demise of Canpotex would surely follow any degree of control by the Chinese.

I have suggested the name "Chinpotex" would more accurately reflect the influence of China in Canpotex.  

According to today’s Globe and Mail, the Chinese are close to making a BHP-bettering bid for PotashCorp through Sinochem, or through CNOOC, or one of their subsidiaries.

My guess is the bid should come in about 10% higher than the current stock price of $148 US to satisfy investors and traders, and should be one that would force BHP to hold a shareholder vote if it were to move to top it as would be expected - $160 US/share makes sense.
I think the Chinese are more worried about the Russian Silvinit-Uralkali tie-up than they are BHP and Canpotex. The Russian potash combination will have about 10 million tons of Potash for export.

New Uralkali shareholders just forced the appointment of a new CEO for Silvinit while the now deposed CEO was on extended holidays. Nice talking to you. That should tell you who is in control at Silvinit now.

The biggest potash producer in the former Soviet Union countries, Belaruskali, has converted to a joint stock corporation, and the government is looking for a strategic minority investor, to help fund government deficits and expand production from apprx. 8 million tons/yr to over 10 million tons.

If Belaruskali were to join the Russian combination to make a three-party potash cartel under the Belarusian Potash Company export arm, then the Chinese would be forced to pay much higher prices for potash in the future.

The Russian and Belarusian potash producers have outsold Canpotex in China by a wide margin over the past 2 years.
Adding BPC's export production to Uralkali-Silvinit's and marketing them together would create a potash giant with 18 million tons capacity, exceeding that of PotashCorp.

It was BPC that dropped potash prices to $350/mt last year and this lack of price discipline will be removed if a tri-party potash cartel is formed in the East.
This emerging threat for the Chinese has been brewing all summer, as Russian tycoon Suleiman Kerimov and his business associates amassed controlling positions in Uralkali and Silvinit.
The BHP bid for PotashCorp is turning out to be the best thing that ever happened to Chinese potash buyers. It put POT in play, and gave them an excuse to solve their looming problem with the Kerimov group potash block.

Alternatively, the Chinese could surprise and buy the minority stake in Belaruskali, dropping the PotashCorp bid. That is a serious possibility, but it appears blocking BHP's ownership of PotashCorp is one of the Chinese main motivations. In addition, there is competition from Rio Tinto plc (RTP) for the Belaruskali minority investment, rumoured to be offered at $6-7 billion US.
On the overall stock market: We bought back some of our favorite Canadian telecom shares. We were selling into the ex-dividend dates but since the BCE/CTVgm deal, we have held the BCE (NYSE:BCE) and bought back TELUS (NYSE:TU) as likely takeover bait.
We have also added Canfor Pulp Income Fund and Fibrek to our active buy list as NBSK pulp prices have stabilized at $950-970 US/mt. We also own a variety of commodity small-caps and ETF’s.
Canexus Income Fund has solved their commissioning problems at its new Vancouver chlorine/caustic soda plant and Eka the largest pulp chemical seller, has raised prices. We like Canexus for both income and takeover appeal.
A five day Chinese trading holiday on Wednesday starts so the PotashCorp bid could take until next week to be unleashed.
Enough time for our largest Canadian pensions to step up and put together a competing bid to save a “unique” company in Canadian mining and agriculture.

But more likely, the Chinese will do everything they can to win a piece of PotashCorp, given the alternatives.
Disclosure: Long PotashCorp