Agri-Stock Interest Boosts TSX but Slower Growth Scenario Casts a Shadow

Agri-stock interest boosts TSX But slower growth scenario casts a shadow

August 20, 2010 – The TSX must have received an injection of potassium last week. It’s the only reason we can think of why Toronto’s benchmark index ended the week with a noticeable advance, while the big US indexes posted small declines on the week. Fact is, there really wasn’t much to celebrate, other than the fact that BHP Billiton Ltd., the world’s largest mining company, decided that it absolutely, simply, had to have Canada’s largest fertilizer company, Potash Corp. of Saskatchewan, and launched a hostile takeover bid to get it.

Last week’s 7.3% weekly advance in the S&P/TSX Capped Material Index tells the tale. Component companies like Potash and competitor Agrium Inc. give the index a quick boost of fertilizer last week, even though they had been in a bullish trend since the beginning of July.

The sudden interest in so mundane a material as fertilizer has been stimulated by the recent spike in the price of wheat and wheat futures, given the drought conditions in much of Russia, one of the world’s largest wheat producers. The surge in the share prices of fertilizer and chemical companies is a natural knock-on effect of this, as investors reason that demand for those materials will only increase as farmers rush to cash in on high prices while wheat demand outstrips supply in the short term. Related industrial companies, such as Caterpillar Inc. and Deere & Co., also are expected to benefit as demand for heavy farm machinery is increases commensurately.

Maybe. A five-year price graph for Potash is instructive.

The last time Potash climbed to new highs, there was also a shortage scare in soft commodities, as the government-mandated ethanol craze peaked and rioting erupted in various parts of the world, owing to temporary shortages of wheat, corn, and rice. But that passed as warehouse inventories were replenished relatively quickly. All of which contains an object lessons for those tempted to follow commodity cycles. Generally, by the time you learn that that there’s a mania on, it’s too late. All the big money has been made, and chances are the market is ready for a peak blowoff. It could happen now, with recent agri-stock runups already discounting future earnings growth. And if the primary driver of the current investing theme is the price of wheat today, then the sustainability of the rally in agri-stocks is questionable indeed.

BHP might be correct in hunting down agri-assets like Potash Corp., based on the theory that over the long term (emphasis on “long”), agriculture is decidedly a growth business (yes, pun intended), especially with rapidly growing Asian demand. But buying into a story at the height of a mania doesn’t make much investment sense.

What, then, are we to make of the price of gold, and gold mining companies? Giant hedge funds have been loading up on the stuff through equally gigantic purchases of exchange-traded gold funds like the SPDR Gold Shares ETF, which holds about US$50 billion in gold. Paulsen & Co., for example, has a stake worth roughly US$4 billion in the fund. Soros Fund Management holds about US$600 million.

Peter Munk, the Chairman of Barrick Gold Corp., the world’s largest gold mining company, said last week in an interview reported by Bloomberg that the company has no plans to hedge its production against price declines. He sees more potential for price upside given current economic conditions than downside. We assume Mr. Munk has thought about this a lot, given that Barrick now has unhedged gold reserves of about 140 million ounces. Of course, gold would have to drop by about US$600 per ounce from its current level of US$1,227 before virtually any gold mining company anywhere even begins to worry about losing money. There would have to be one heck of a deflationary collapse for that to occur.

And while there is vociferous contingent of economists and analysts who issue regular proclamations of imminent deflationary collapse, it’s hard to see how that could happen. Given the huge fiscal hole most Western government have dug for themselves, most notably the US, the only longer-term scenario that makes any sense is one of rising and intractable inflation, as governments follow the time-honored recipe for extricating themselves from unmanageable debt – monetization.

In the next few years, Ben Bernanke, the Chairman of the US Federal Reserve Board will well and truly earn his nickname “Helicopter Ben,” bestowed following a speech in 2002 in which he said the only way out of deflation is to print money and drop it out of helicopters to the streets below. Right now, US consumer price inflation is subdued as the economic recovery loses some momentum, an event widely predicted by many observers in the first half of the year. And the Fed is busily preparing to resume purchasing US

Treasury debt, if things start to get worse, at least if St. Louis Fed President James Bullard’s numerous recent utterances on the subject bear any weight at all.

Canada isn’t in such dire fiscal straits as the US or some European countries, but our economic growth is highly influenced by what happens elsewhere. It’s with some interest, then, that we watched Canada’s headline inflation rate climb to an annual rate of 1.8% in July, even as the core inflation rate, which excludes volatile food, energy, and the effect of the HST in BC and Ontario, slipped to 1.6% from 1.7% in June. This has increased the probability that the Bank of Canada will pause in its rate-hiking program, at least in September, as it assesses whether the small slip in the core inflation rate is a harbinger of a steeper slide in economic growth through the third and fourth quarters.

Toronto’s S&P/TSX Composite Index posted a 1.7% weekly advance, spurred on by advances in materials and gold, overcoming a slide in the energy sector as the price of crude oil dropped US$73.97 per barrel. The Dow Jones Industrial Average slipped a modest 0.9% on low volumes, week over week, while the S&P 500 Composite Index edged down for a loss of 0.7%.

As the dog days of summer progress, markets remain in their holding pattern and are unlikely to see any major trend breakouts until the fall.■

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