Potash as Ash Can

By the time you read this, the crop report will be old news. We don't expect any big surprises, nor does The Street. The expectation is that corn plantings will be down, soybean plantings will be up, and cotton will probably get the weakest planting of all.

One of the more interesting plays on these kinds of numbers has been potash. Potash, which you can get from burning wood - but is more often mined - is a critical fertilizer. The three biggest demand sources are Corn, Soybeans and Cotton, in that order. So the algebra for the big potash companies is what the shifts will be.

Cotton, Corn and Soybeans can be interchangeable on the same acreage. So less cotton and more anything else is a plus, but less corn is a minus. It's safe to assume that the market has priced in the median assumptions, and that all today brings is volatility.

The "pricing in" in this case, is in the three big public potash plays: Potash Corporation of Saskatchewan (NYSE: POT), The Mosaic Company (NYSE: MOS), and Agrium Incorporated (NYSE: AGU). While all three have businesses other than potash, they are, in descending order, the big fish - with POT alone controlling 75% of the surplus Potash available on the spot market.

The three companies share a common exporter, Canoptex, jointly owned and focused on sales in Asia. While 60% of Canoptex's potash ends up sold on the spot market, the remainder is sold in long-term negotiated contracts, much like iron ore. As a joint marketer, it has tremendous pricing power and enters into long-term contracts with international firms - in other words, China. China and India have become tremendous sources of demand for bulk potash, and the bottom line is there aren't that many places for them to get it. Canada and Russia are pretty much it.

This year's big contracts with China and India from Russia were just struck, at a time when the spot prices are twice what they were last year ($625 per ton). This left the market salivating at the prospects of the big North American firms' prospects for high-margin, peak-priced contracts, saliva so far well justified as Mosaic announced a deal to supply India at the same prices on Friday. None of this is news to potash-supplier shareholders of course, and the result is fertilizer companies with P/E ratios that put Apple and Microsoft to shame (but which are increasingly common in hot commodities stocks)

And this also comes at the end of a phenomenal bull run for the companies concerned

One-year numbers like that make the commodities boom seem boring by comparison. But look at the volatility. These are heavily played stocks, subject to wild swings (as Brad recently pointed out). Analysts have been jumping on the buy wagon, earnings estimates keep getting revised up, and the China card is being played more and more heavily in every article. In a world where pure-plays in commodities are increasingly difficult to find, POT and MOS have represented rare speculative gems. Good for long-term holders, dangerous for newcomers.

The next four weeks are critical if you're playing the home game. Mosaic releases earnings on April 4, with Potash following shortly thereafter on April 24. This is a classic case where a micro-sector has gotten hot in a hurry, and the fever is about to peak. This doesn't necessarily mean anything is going up - new investors may indeed pile in as Jim "Bear Stearns is Fine" Cramer whips them into a frenzy over POT, but then, a lot of smart money was in these stocks last March and may be looking for the exit signs on bigger news-driven pops.

What it does mean is volatility. MOS's one-year volatility is already over 67% (vs. 25% for, say, the Goldman Sachs Commodity Index). The ride's only going to get wilder.