Buy Me Not

When it comes to commodities, sometimes one man's ceiling is another man's floor. The faster the price shoots up for a basic input like crude oil or natural gas, the tougher it gets for some producers to maintain profit margins.

Why does this matter, you ask? Because price patterns in oil and gas can sometimes tell you when not to buy into a certain sector or group -- in this case, fertilizer stocks. Andrew Mickey explains how a little bit of patience could pay off here. Take a look.

Warm Regards,

JL

 

 

Natural Gas Boom Spells Short-Term Doom for Fertilizer Stocks

The fertilizer industry uses a lot of natural gas... and I mean a lot. Fertilizer can't be manufactured without gobs of it. According to the GAO, "Natural gas is a key feedstock in the manufacturing of nitrogen for which there is no practical substitute."

We can see the impact of soaring natural gas prices on fertilizer costs. In the chart below, the National Agriculture Statistics Service shows us how natural gas prices can destroy profits of fertilizer producers.

 

In 2001, natural gas prices spiked from $4 to $10 in three months. Meanwhile, nitrogen fertilizer prices only rose from about $200 per ton to about $325 per ton.

A lot of factors play a part in a 150% move (the amount by which natgas prices rose). What's perfectly clear is that fertilizer companies paid the price. While they had to pay 150% more for one of their major inputs (natural gas), they were only able to charge about 60% more for their product. When companies are unable to pass increased costs onto consumers, their shares can experience drastic sell-offs.

The dreaded natgas spike hit fertilizer stocks in late 2000... then hit them again in 2003... and then yet again in 2005, when the hurricane season pushed natural gas prices to extremes.

Following Hurricane Katrina, the fertilizer sector was hit with a 20% sell-off. The most natural-gas-dependent producer fell 40% after Katrina made the official leap from tropical storm to hurricane.

Priced for Perfection

Of course, we'd expect it all to be priced in by now right? After all, three times in the past decade natural gas prices soared and fertilizer companies got hit hard. And yet, in this case, history has been forgotten once again. The price of natural gas has risen 80% this year, yet fertilizer stocks are still going strong.

Expectations are high -- too high. Any fertilizer company that comes up short this earnings season is going to pay a heavy price.

Potash Corp (POT:NYSE) is a good example. There have been seven analyst upgrades for Potash Corp in the past month. Consensus estimates for Potash Corp's Q2 profits were $1.98.

Now, Wall Street is expecting $3.23. That's a 63% increase in estimates in only a month! Potash prices are up, and the long-term picture can hardly look better... But Potash Corp is now a $70 billion behemoth. Earnings rarely grow that fast when you're that big.

Again, expectations are just too high for the near term. And natural gas prices are going to cause a lot of fertilizer stocks to miss expectations. Given current market conditions, this is no time to come up short in the earnings department.

It's Just Business

The next big opportunity I see is going short some of the major fertilizer stocks. Soaring costs and lofty expectations are rarely a profitable combination for investors looking to buy and hold.

In my premium investment advisory, Fear & Greed, we started tracking this situation almost two weeks ago. I warned "the race to fertilizer stocks is about to take a pit stop."

Since then, the bubble showed the first signs of popping. All of the hot fertilizer stocks we were avoiding have been hit hard. On average, they've fallen 15% in two weeks. But they're starting to rebound now, and things are shaping up for another big drop. Out of fairness, I can't reveal the three fertilizer stocks that are most dependent on natural gas (and thus likely get hit the hardest).

But I can tell you a few things... like the fact that during the Katrina aftermath, these three stocks fell 20%, 35%, and 40%.

One of the three stocks -- which I originally recommended two years ago this week -- is up 280% in the past year. All three had upward revisions of earnings estimates from the money chasers on Wall Street in the past four weeks.

Most importantly, we have a very near-term catalyst when all three of these fertilizer companies report earnings at the end of July.

The bottom line is this: If you're looking at buying into fertilizer now, it's best to wait -- and you might even want to join me in going selectively short.

If history and the price of natural gas is any guide, there's probably a much better buying opportunity for fertilizer stocks just a short distance away.

Best,

Andrew Mickey
BreakAway Investor