I will be attending the Hard Asset Conference in New York a little later this month where I am sure the topic of gold will be hotly debated. For one, I believe that gold is relatively cheap and will make its way considerably higher. As for gold equities, they are trading at valuations only seen once in the last thirty plus years and despite all those who argue that gold ETFs have killed gold stock investment, I would not be too quick to count these stocks out.
With that said, I would like to talk about a more important commodity for mankind. Yes, gold is important for those who are concerned about purchasing power, currency devaluation and a general hedge against economic and political uncertainty but when push comes to shove, could anyone really argue that anything is more important than food?
All food is grown (crops, fruits, vegetables, etc.) or comes from animals that themselves survive on things that are grown and, in order to grow things, we need fertilizer. Fertilizer in comprised of nitrogen, potash and phosphate and whether you realize it or not, North America has a problem when it comes to phosphate because North America is not self-reliant. Canada has only one operating phosphate mine (Agrium’s Kapuskasing Mine) which is scheduled to close within a year and Florida’s operations have had issues mostly brought on by environmental concerns. The result is that North America’s deficit will continue to grow adding to our reliance on foreign countries to offset this shortage.
Many people understand the importance of Saudi Arabia when it comes to oil as it represents roughly 10% of the world’s supply. When it comes to phosphate, Morocco makes up 35% of the world’s export market, making it 3.5 times more important when it comes to fertilizer and thus food. Other North African and Middle East countries are significant producers as well and, with last year’s “Arab Spring” uprisings, North Americans better pay attention. Imagine, if you will, what a supply disruption would mean to phosphate supply around the world and, especially North America where currently 100% of our deficit is supplied by this region. Agrium has already announced that its current plan to make up its deficit caused by the Kapuskasing closure will be to get additional supply from Morocco. North America is not alone in its predicament as growing economies also struggle with mounting populations and an increasing desire for higher protein diets. India is currently the world’s largest importer of phosphate; importing roughly 8 million tons a year. Fortunately, China which is a large producer of phosphate is self sufficient but large export taxes keep their supply from the global market.
All of this has resulted in gradually higher prices, and although the phosphate market is generally a contract market, the closest thing to a “benchmark” would be Moroccan FOB which currently sits at roughly $200/ton. I say the “closest” because unlike gold or copper, phosphate can differ greatly depending on where it comes from and the nature of the deposit. While Moroccan phosphate trades at $200/ton, higher grade phosphate from some Russian deposits can fetch considerably more. Lastly, like other industrial commodities, issues such as transportation are considerable factors.
So with this in mind, as an investor what can we do to perhaps profit from this situation? As you might expect, our fund (as well as me personally) are investors in companies that we think will benefit from the growing demand for “safer” supply and, unlike potash where there are literally dozens of publicly traded opportunities, quality phosphate investments are much harder to find. First and foremost, location is paramount and since it is North America that has the problem, we like North American deposits. Second, as a general investment thesis, we like companies that are wholly leveraged to a particular commodity so that IF we are right, we are really right. With that, there are a couple of companies that are one trick ponies (phosphate), North American based and have advanced their deposits to the prefeasibility stage.
Our favorite in the sector is Arianne Resources (DAN: TSX-V). The Quebec based company has a very large deposit that, at last calculation, contains 500 Million tons of ore grading roughly 7% P2O5 (phosphate). It is important to note that the “in situ” grade is not what is important but what is, is the end product and since this deposit is igneous it makes a concentrate of 39% (30% higher than Moroccan) which it can sell for considerably higher prices. The prefeasibility has shown Arianne’s project to be very robust. It has an NPV of roughly $650 million but if one were to factor in today’s phosphate prices, the number is closer to $1 billion. As well, the size of the deposit gives Arianne the ability to supply 30 plus years of production and is in trucking distance to both the North American rail-head and a deep sea port.
Another company worth looking at is Toronto listed Stonegate Agricom (ST: TSX). The Company’s primary deposit is in Idaho, another prevalent area for phosphate production. Although currently a relatively small deposit with a small production profile, the grades are such that the company may be able to direct ship their ore as opposed to having to beneficiate their rock as most producers do. The result is a low capex, economically viable project that should provide very handsome returns. Stonegate also has another asset in Peru which it is moving forward with.
At the end of the day, North America needs this stuff and if I am one of the larger fertilizer producers, how comfortable can I be if I am not 100% vertically integrated? The math is pretty simple too; I can pay $200/ton to another producer or save at least $100/ton by owning the production myself. In the case of Arianne, at 3 million tons/year of production, it is a $300 million annual difference between buying phosphate on the spot market and owning the deposit outright. In the case of Stonegate’s Idaho deposit, the difference is $100 million annually.