August 23, 2010

Economic update

Potash in demand as global economy strengthens

ALEX CARRICK

Chief Economist, CanaData

Much can be learned about the economy by analyzing shifts between the five major asset classes — stocks, bonds, currencies, commodities and real estate. These investment vehicles are linked together in complicated ways, often moving in tandem, but at other times inversely.

Currently, North American investor interest is mainly focusing on the stock markets. With interest rates about as low as they can go, the prospect for capital gains from holding bonds is diminished, since resale prices of existing debt instruments drop as interest rates rise.

As for real estate prices, they are deeply depressed in the United States. The S&P/Case Shiller index has been recording some minor improvement versus a year ago. But the days of speculative home price increases are only a memory and the next round is many years away.

The latest report from the U.S. Mortgage Bankers Association showed a 13% gain in mortgage applications week over week. Bargains in interest rates are appealing to homeowners. But the gain has been for mortgage refinancing as opposed to new purchases.

With respect to other real estate, the problem of commercial mortgage defaults will play out over the remainder of this year. Office vacancy rates are high in most centers and need to come down dramatically. This market, similar to the homes market, requires a pick-up in employment.

In currencies, the euro appeared vulnerable earlier this year (with accompanying strength in the greenback) as sovereign debt problems became obvious in Greece, Portugal, Spain and Ireland. The not-so-surprising result has been a surge in Germany’s exports. This has helped to stabilize the continent’s exchange rate.

As for commodity prices, particularly for base metals and fossil fuels, they received a huge boost from massive infrastructure spending in China last year and into 2010. Accompanying strong growth by other Asian Pacific nations also contributed to some commodity prices hikes.

Anticipating the enormous demand that will be coming from emerging nations over the next decades, major resource companies are working to lock up supply longer time. The latest evidence of this is found in BHP Billiton’s hostile bid for Potash Corporation of Saskatchewan.

A couple of years ago, during the world-wide food shortage, Potash Corp. was the largest company by capitalization on the Toronto Stock Exchange. Potash is a key ingredient in fertilizer mixes that raise agricultural output. The recession lowered potash prices and the company has fallen back in the rankings on the TSE to sixth position.

BHP (Australia) is anticipating the next round of food shortages. A 25% premium on Potash Corp’s pre-takeover-bid share price has materialized as a result of BHP’s attention and competing bids are considered likely. It would not be a surprise if a Chinese government entity entered the fray.

Canada has already lost a goodly number of its former marquis companies to foreign purchasers. The list includes Alcan, Inco, Falconbridge, Stelco and Dofasco. What will be Ottawa’s reaction to one more Canadian resource giant being absorbed by a foreign interest? Consider the options.

On the downside, there is the blow to national pride. The upside derives from infusions of cash. It is imperative that these firms remain vibrant and competitive. Ownership must have the deep pockets to undertake the expansions and productivity improvements needed to compete globally.

Some major oil, gas and pipeline firms remain in Canadian hands. The banking community also remains largely intact, thanks in large part to government intervention. At the same time, Canada’s banks have not been allowed to merge and become bigger players on the world stage.

Canada’s financial sector won kudos during the financial crisis. The evidence from almost every other corner of the economy suggests that in the new global environment, firms either supersize or they are absorbed by even larger entities. One of the few alternatives is to survive by means of government protection.

That is not the means to the most productive operations longer term.

For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at www.alexcarrick.com

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