Monday, August 4, 2008

World's Largest Fertilizer Company Buckles

Potash Corp. (POT), the world’s largest fertilizer company, broke to the downside today after posting stellar results for the second quarter. Another potash stock, Mosaic (MOS), also broke down today. Is this the beginning of an important downtrend in potash stocks or is this just a correction that creates a buying opportunity?

You might want to read this technical article from istockanalyst before you decide to buy or sell Potash. In the near term, there is clearly a downtrend forming.

I quote the following (click on charts above to enlarge):

Based on quick analysis, we have lengthy and persistent negative momentum divergences since April, and momentum is accelerating to the downside now.

The $190 per share level provided solid support in the past, and now that level has been broken to the downside, and there is a descending trendline ahead, which completes a possible ‘descending triangle’ distribution chart pattern.

Classical technical analysis uses price projections from the height of the triangle, which is at $240 down to $190, which would mean a possible downside target would be projected down $50 from the triangle break at $190 to be placed near $140 per share (blue arrow).

I have an initial target near $165 per share, which corresponds with a test of support at the 200 day moving average (currently at $165.69 per share) and the weekly 50 period moving average at $161.89, which is flattening out).

This chart cleanly shows a ‘non-confirmation’ by volume, as higher prices were met with less enthusiasm and lower volume readings (also there was a negative momentum divergence, which is not shown). The weekly ‘gravestone doji’ in June at the top of the Bollinger Bands - when combined with a negative divergence from momentum and volume - served as an excellent, high-probability short-sell (or exit for long positions).

With the 20 week EMA violated, a potential target of $160 per share is established as sort of a ‘magnet trade’ or possible ‘impending test’ of the ‘next line of support’ via the 50 week EMA.

Another article by Horacio Marquez, a former vice president of the Merrill Lynch Emerging Markets Fixed Income Group, looks at the breakdown in Potash from a fundamental angle:

...despite posting superb profits that handily beat earnings estimates and raising outlook, the stock sold off, together with the rest of the sector. That’s partly because commodity prices have dropped back, causing related stocks to do the same. The stock-price decline, in the case of Potash, also has a company-specific negative component: Workers are threatening to strike at three mines that account for roughly 30% of Potash’s output. Without question, a strike could negatively affect Potash’s output – even as it raises the price of potash globally, helping the company’s rivals in the near-term.

However, the aforementioned sell-off in commodities has been driven by several important factors:

  • Short-term momentum players and some institutional investors have moved away from the so-called “ethanol trade,” since electoral uncertainties raise probability that next year’s ethanol subsidies might be reduced or scrapped altogether. This worry also has affected Archer Daniels Midland Co. (ADM), a prime beneficiary.
  • The U.S. dollar has been climbing against both the Japanese yen and the European euro, especially now that Europe has started to slow, a victim of its appreciated currency tight monetary policy. Some emerging economies also tightened their monetary policies to curb inflation. In this environment, commodities as hedge for inflation have lost some appeal, at least for the moment.
  • This slowdown and demand destruction, in part because of higher prices, have also induced oil prices to decline, and that, in turn, has helped reduce overall inflationary pressures – reducing the need for investors to hedge energy with grains and other agricultural commodities.
  • Summer in the United States has not seen extreme temperatures nor hurricanes, so this year’s crop has only been mildly affected by floods, unlike last year’s weather-induced crop losses. Benevolent weather has also helped lower the price of oil.
Mr. Marquez adds:

On the positive side, emerging-market urbanization, and the accompanying consumer boom (all driven by strong growth in real incomes) is alive and well and will continue unabated for the long-term. So, at some point, Potash and its competitors will become a compelling long-term “Buy.” But the uncertainty regarding the U.S. ethanol subsidies, which originally helped fuel the demand for fertilizer, is too difficult to call at this point.

With most investors having captured massive profits in these stocks and with a high probability of seeing next years’ capital gains taxes increased, there is a strong incentive to take profits now.

Therefore, I would lock in profits and wait for an opportunity to get back into this stock closer to the year-end. You’ll want a bit more clarity about the prospects for continued ethanol subsidies and lower prices to get back into this stellar company and its main peers in the sector. And stay tuned for news on the Potash strike.

The breakdown in Potash is significant because along with the plunge in oil prices, it might confirm that the world economy is slowing faster than we think. If this is the case, then watch for a strong correction in commodity currencies like the Canadian Loonie. In fact, currency traders are already pricing in a slowdown in the Canadian economy. When the S&P/TSX opens tomorrow, expect nervous stock investors to take profits in the high flying commodity sector. The only problem is that in a full blown bear market, they do not have many alternatives to reallocate to. Stay tuned, things are getting very interesting.

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