As counterintuitive as it sounds, investors in the fertilizer sector should look to North American corn prices before corporate earnings. The corn price has proven a better indicator of future profits than either trailing earnings or analyst forecasts.
The chart below shows the relationship between the Alternative Investment Analytics' Corn Spot Index and Potash Corp. stock since 2000, highlighting a remarkable 0.92 correlation. For comparison, Potash's trailing earnings have only a 0.79 correlation to the stock price.
The simple logic of supply and demand lies behind the trend. Trailing earnings tells investors about the past while the corn price signals the future. When North American corn prices rise, global demand for fertilizer rises and farmers are willing to pay a higher price. The phenomenon works the same way in reverse. In effect, current corn prices determine future sales for Potash.
With continuing drought conditions in the U.S., the link between fertilizer stocks and the corn price could prove all important for 2013. Canadians don't often consider soil conditions in the winter months, but the Nebraska-based Drought Mitigation Center reports that extreme and exceptional drought conditions remain in almost 20 per cent of the United States. Continued dry conditions would limit crop yields during the 2013 growing season and send corn prices – and fertilizer stocks – significantly higher.
Our chart also signals that now is a potential entry point for Potash investors. Recent news of slowing revenues from China has hurt the stock while corn prices have continued higher. History suggests that the divergence is only temporary and the stock will rise to tack closer to the corn price index. This process may already be under way – Potash and Agrium are two of the top six individual contributors to S&P/TSX composite index performance so far in 2013.