globeandmail.com
    Globe Advisor is moving, click here to see

Advisor Invest With Confidence

Is it time to buy the dip in commodities?

German firm invests heavily in new Saskatchewan potash mine – the first in 40 years. Is it a signal to look anew at the commodities sector?

By: KATHY KERR

Date: October 6, 2017

The first new potash mine in Saskatchewan in 40 years opened in May this year and produced its first marketable tonnes of the fertilizer ingredient in June.

K+S Potash Canada, a subsidiary of German firm K+S AG, will employ 400 in Canada by the time the Bethune mine is fully ramped up next year – at the mine site itself, at K+S Canada’s head office in Saskatoon and at the company’s port facility in Vancouver. Canadian Pacific Railway Ltd. built 30 kilometres of rail to the mine site. Is this surge in investment a sign that the decade-low prices of potash have turned the corner? Is it time to jump into the market?

Analysts agree that potash prices have probably reached their lowest point and are on the upswing, but they also talk about a long-term rise dependent on a growing demand for fertilizer.

The numbers for several resources, from oil to crops to base metals, have been grim for the past two years. If you believe in “buy low,” this could be the time to take a look at the commodities sector. Demand for Canadian resources in markets such as China, India and South America should rise over time, say analysts.

The long game for commodities that requires lots of lead time for development is well illustrated by the potash example.

At the K+S head office in Germany, spokesman Michael Wudonig says the timing of the opening of the Bethune mine had more to do with the company’s long-term commitment to potash than the expectation of a sudden price surge.

When the firm committed to the project in 2010, potash was selling into the Brazil market, one of the target markets for Bethune’s production, at $400 (U.S.) a tonne. By this summer’s startup of production, the Brazil price was about $260. The firm has put $4-billion (Canadian) over six years into the mine.

That said, Mr. Wudonig says K+S sees long-term demand for potash and increasing prices. “We believe in the attractiveness of the potash market because this is our business and there’s always ups and downs. In the mining industry, we think very long term,” he says. “So while the prices went down for one or two years, in the meantime they have recovered somewhat. We think the lowest point is already behind us.”

His firm, which produces only potash and salt, needed new capacity, so Saskatchewan beckoned. “In Germany, in Europe, it’s pretty obvious within the next 30 or 40 years we are running out of potash. We need new capacities. Canada is for us very important to get new capacities to stay in the market and be able to grow in the market.”

The firm plans to sell potash to Southeast Asia and North America, in addition to South America.

Hans Albrecht, vice-president and portfolio manager at Horizons ETFs Management (Canada) Inc., says for investors, “the potash play rears its head every five or six years and everyone gets on board. You know certainly there are people out there who are bullish on it. I think it’s something that plays out over time. Of course, it’s all about China and it’s all about the emerging markets and the demand for potash itself. . . . I think it’s not a bad place to have a small allocation.”

Mr. Albrecht says those who believe that developing nations are going to continue to grow may also put money on something like potash, because of the growing demand for fertilizer. “Those stocks can be quite volatile actually. I think you want to wait and buy the dip, and I think you’re getting a dip.”

Here’s what some analysts and economists are saying about other Canadian commodities:

Crops and livestock

J.P. Gervais, vice-president and chief economist for farm lender Farm Credit Canada, says the outlook globally is for a steady rise in demand for Canada’s crops and livestock.

Canada’s farm economy should benefit from increasing demand in the developing world for higher quality food and more protein in their diet, says Mr. Gervais. “I wouldn’t bet on pricing just skyrocketing because demand is going to increase suddenly. I just think it’s a long-term bet.”

Despite recent years of bumper crops, the supply-demand equation is pretty well balanced now, Mr. Gervais says.

There are risks. Canada needs to increase transportation capacity to get its product to market and the somewhat unknowable Chinese economy is always a factor. But generally Mr. Gervais sees agricultural prospects being good for producers and companies able to tap the export market or, on the domestic side, businesses able to integrate from farm to fork.

He sees oil seeds doing well, thanks to “seemingly infinite demand coming out of China.”

The price of wheat is less certain. “One trend to keep an eye on long term is the shift in acres allocated to corn and soy beans. Corn and soy beans are pushing westward, taking acres away from wheat.”

He also expects a pretty good year for red meat, although feed prices will be high. “This year, income will pretty much remain constant – but we’re at record levels. The last 10 years have been like no other 10-year period,” says Mr. Gervais.

Nick Exarhos, director and senior economist at CIBC World Markets Inc., also sees a switch from a negative to a positive trend for agricultural commodities on the year-over-year basis.

“A richer emerging market consumer eating a more protein-rich diet in general is a strong sectoral tailwind, so long-term dynamics are pretty constructive in that area,” says Mr. Exarhos.

Toronto-Dominion Bank economist Dina Ignjatovic adds that the global demand for biofuels will also increase the demand for crops.

Oil

Mr. Exarhos says CIBC feels some analysts are too optimistic about oil prices for 2018 and 2019. CIBC is expecting some recovery in prices but only toward the $55 (U.S.) to $60 a barrel level in 2018. For Canada’s oil sands, that’s not quite up to the $65 level needed to spur new projects, says Mr. Exarhos.

“We’re forecasting flat to negative oil demand growth for developed markets and close to a million barrels a day of demand growth for emerging markets,” he says.

Analysts agree that countering that demand growth are surplus supplies in the United States and the question of whether OPEC and non-OPEC producers will maintain a tight rein on supply.

Ms. Ignjatovic says the supply glut is a concern, but now that there is better compliance on limiting supply by the non-OPEC group, those surpluses should come down. She said there should be some rebalancing toward the end of this year.

Mr. Albrecht of Horizon ETFs has a positive outlook on oil and particularly oil companies, which he thinks will outperform their commodity. Resource companies have been strengthened by some tough years, he says. “What we’ve seen in the last five or six years is that companies have become much more lean; much less concerned about capex [capital expenditure] and more with actually running a good lean, solid company. … You can’t spend like a drunken sailor when things start to lean out and demand disappears.”

Those more solid fundamentals on the corporate side extend beyond oil, says Mr. Albrecht. “This is true of oil producers and gold producers and base metal producers and agriculture producers as well. You’ve got companies that are set up to do well and all you need is this improvement which I think we’re going to get – this slow trickling improvement in global growth and commodities and those sectors will become a narrative again at some point.”

Gold

Gold continues to be buffeted by contradicting market forces and economic policy currents and analysts are neutral on the prospects for the coming year.

Mr. Albrecht says when interest rates are as low as they have been in recent years, gold has a special attraction. “You’re telling people you’re going to lose money on cash and that becomes very interesting for things like gold – something you can touch and feel.”

But if interest rates take off, gold becomes less interesting. “I don’t think it’s going to run away. . . . I’m pretty neutral on it,” says Mr. Albrecht.

Mr. Exarhos also has his doubts about gold’s potential. “As interest [rates] edge higher, the opportunity cost of holding a non-yielding asset like gold increases, so a new headwind will emerge for gold.” He sums up the forecast as flat, maybe down slightly.

Base metals Mr. Exarhos predicts base metals will hold ground through the end of 2017, but then grind lower in 2018.

Ms. Ignjatovic is of a similar opinion, but she says zinc will outperform because of a strong demand in China. She says zinc should be selling for about $1.40 a pound by the end of 2018, up from a level of about $1.23 in the summer.

Copper is expected to stay fairly flat, she says, and aluminum prices will fall a little bit. Nickel prices are predicted to rise but there is a downside risk that Indonesia may ramp up supply and that would lead to downward pressure, she says.

Prices perk up Summing up, Mr. Albrecht suggests the time is right to buy in the commodities sector as prices perk up after languishing for months and resource companies emerge from tough times leaner and better.

“Why not buy these sectors when they’re on sale instead of buying them when there’s euphoria?” asks Mr. Albrecht.

“Things are trading at good valuations and, I love Amazon and all those stocks, but you have to think there’s the potential for that wonderful growth in the commodity area as well. It just works in a different way.”

Commodities in your portfolio

There are several options available for retail investors wanting exposure to Canadian commodities.

  • Stocks in oil, mining or lumber companies or those businesses likely to benefit from a commodities surge, such as railways.
  • Mutual funds with a weighting in the commodities area.
  • ETFs or exchange-traded funds. There are single commodity ETFs, ETFs for a basket of commodities as well as ETFs covering companies involved in commodities.
  • Commodities futures: direct investing in commodities. This requires an account with a broker licensed to trade in commodities and requires a level of commitment and sophistication not all retail investors have.

Advisor Invest WithConfidence

 

The Rise of Alternatives Fast-casual chains have room to grow