No matter how good or bad the economy is, people have to eat. And in good times and in bad, maximizing yields is very important, says Yiannis Mostrous of Investing Daily.

Grain prices suffered tremendous volatility last year, which removed much of the froth from their previous run-up.

The resulting uncertainty caused farmers to delay new fertilizer purchases, which pushed fertilizer prices lower. Nitrogen and phosphate prices dropped well below their support levels. And urea prices fell from over $500 per ton to $300 per ton.

While the long-term fundamentals for the agricultural sector remain intact, investors are enduring a 17% decline in agricultural commodity prices since last year’s all-time highs.

At present, the corn market is of particular interest. The ERUR (end-stocks-to-use ratio) for corn suggests that the global corn market is vulnerable to a sudden supply or demand shock, as the indicator has been hovering near record lows.

Although there have been upward revisions in crop sizes around the world, the supply is not nearly as ample as is generally believed, and any disruptions could significantly alter the supply-demand balance.

Nevertheless, fertilizer stocks should be major beneficiaries of a rally in agricultural-sector equities later this year. In fact, the declines in the sector over the past year have reduced valuations to levels last seen more than two years ago.

At these levels, fertilizer stocks are more than pricing in the recent decline in agricultural commodity prices, and further downside appears limited unless there’s a new global economic recession. Indeed, bad news about the Argentinean corn crop or a delay in the US corn planting season could send prices back to their highs.

Potash Corp. of Saskatchewan (POT) is our top pick among fertilizer stocks because it offers exposure to all three major fertilizers. The company controls nearly a quarter of the world’s total potash mining and production capacity, and is by far the largest player in this market.

The potash market is an oligopoly, with the six largest players essentially controlling the market. These companies have proved adept at managing supplies in recent years, maintaining pricing and margins by shuttering production facilities following declines in demand. And Potash Corp’s mines in Canada are among the lowest-cost sources of this key fertilizer in the world.

The company suffered a weak fourth quarter, as Asian demand slowed and dealers and distributors delayed new orders because of economic uncertainty. However, management suggested that despite a decline in its fertilizer sales during the fourth quarter, actual applications of fertilizer by farmers remained strong, an indication that producers and distributors have been drawing down their inventories.

As we noted in a recent commentary:

“…while such caution is expected to continue into the first quarter of this year, the US spring planting season is just a few months away, and agricultural economics are still attractive even if prices are off their highs.”

"The US Dept. of Agriculture raised its estimate of last year’s corn crop in recent months, but poor growing conditions throughout much of last season stressed crops and hurt yields. Farmers are expected to aggressively plant acreage this year in an effort to offset that showing. The company expects that to lead to more robust sales as the year progresses and dealers restock their inventories.”

The bad news about near-term potash demand appears to be baked into valuations, and Potash Corp. of Saskatchewan should be bought at current levels.

Read more from Investing Daily here…

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