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Plunging Resource Supplies Results in Soaring Profits

Commodities / Resources Investing Apr 24, 2008 - 06:15 PM GMT

By: Yiannis_G_Mostrous

Commodities Best Financial Markets Analysis ArticleThe most powerful stories in fiction, as well as in investing, have always been simple: love, hate and war for the former; demand, supply and basic needs for the latter. And no story fits the bill better than food and agriculture, for which demand is ever present.

The global population, currently at 6.5 billion, is expected to surpass 9 billion by 2050. Income is surging, especially in emerging economies led by India and China. That means greater demand for protein-rich foods and more crop grains for feeding. Moreover, growing demand for affordable energy has created an explosion of biofuels, diverting food resources from eating to ethanol and bio-diesel production.

On the supply side, arable land is being paved over on a global scale, with China at the forefront. Clean, safe water is increasingly scarce. Climate changes—no matter how short term—are a reality: Droughts and floods occur with increasing frequency. Moreover, increased livestock feeding pressures the allocation of valuable foodstuffs to animals, and corn is the primary target.

The bottom line: No matter who we are or where we live, we all need to eat. And that's pushing prices sky-high for anything and everything needed to meet demand.

Many of the best vital agricultural resource bets are centered on Asia, the main driver in the rising demand for food over the past 15 years. With strong population growth and rapidly improving incomes, the region is an up-and-coming force in the consumption of almost all food supply categories, particularly meat and milk.

China has been in the forefront of rising food consumption. For example, Chinese pork consumption accounted for 50 percent of global pork consumption in 2006, with demand rising 130 percent since 1990.

Despite that rapid growth, Asia's daily per-capita consumption remains low compared to developed economies. China's meat consumption is still 30 percent of that of the US. Milk consumption is even lower at around 15 percent.

That's a lot of room for future growth and a fairly solid sign the trend has a long way to run.

Asia's strong food demand is a major driver behind regional inflation. China leads the pack again, with food price inflation growing 15 percent a year. Given the high weight food is assigned in developing nations' Consumer Price Indexes, that's not surprising. 

A lot of the developed economies benefit from this revival in the agricultural/resource industry, and Canada is a strong example.

Canada, unusual among developed countries in the importance of natural resources and raw materials, now ranks with the world's top five producers of 14 mineral commodities and leads in the production of uranium and potash, the scarcest of the three main raw materials of fertilizer (along with nitrogen and phosphates). 

Its unique natural bounty could help it survive a US downturn. Between 2002 and 2006, the US share of Canadian exports fell from a peak of 84 percent to 79 percent. During the first seven months of 2007, this share declined to 76 percent. 

In the five years since it gained entry to the World Trade Organization, during the same period Canada-to-US trade has shrunk, China's imports have grown substantially. It's forecast to import nearly USD1 trillion worth of resources in 2007, tripling the USD300 billion of 2002. China's demand for natural resources has driven this rapid growth and has boosted prices for Canada's exports of oil, gas, metals, minerals and farm products. 

Between 2002 and 2007, Canada's exports to China rose from CAD4 billion to nearly CAD8 billion. And there's no sign that trend will end soon: The most recent data for 2007 indicate a 43 percent year-to-date increase from the same period in 2006, a rate of growth faster than any other G-7 country.

As long as Chinese demand keeps commodity prices high, the Canadian economy and the loonie will stay aloft, and the Great White North will ride out a US slowdown. 

Potash, better than any other resource, illustrates Canada's good fortune. The country's potash reserves, at around 75 billion tons, are among the most extensive and the richest in the world. In 2001, the country accounted for about a third of global output. The worldwide leader's share has grown to more than 40 percent on rising demand from China and growth in biofuels production. 

Increasing demand for potash in China is due largely to the agricultural industry in the country, which uses 54 percent of China's total land area. Intense farming robs the soil of nutrients, and a good fertilizer is needed to keep crops growing.

According to a May 2006 report on biofuel development by the International Fertilizer Association, in the 30 years between 1975 and 2005, global biofuel output rose from zero to 30 million tons--a drop in the bucket compared to consumption in 2005 of 1.5 billion tons of oil for transportation. But the biofuel growth rate is accelerating, and production is expected to exceed 80 million tons by 2015.

The biofuel drive is generating new levels of industrial demand for potash. As farmers become biofuel miners, the demand for organic fertilizer has driven up the price for potash, which is required in increasing concentrations to sustain crop yields on the shrinking supply of arable land. Three crops used to produce biofuels require large amounts of potash to boost yields: sugar cane in Brazil, palm oil in Asia and corn production in the US.

Population growth and increasing per-capita income--prime characteristics of developing countries--are driving global demand. Demand, now growing between 3 and 5 percent annually, is widely anticipated to grow faster than producers' ability to add and expand capacity. Taking the more conservative estimate, for every succeeding year, there will be demand for up to an additional 2 million tons of potash, equivalent in volume to the startup of a new mine. 

But it's difficult to get a new mine established and up to capacity; despite a series of expansion announcements, the industry will still be challenged to keep pace with demand. 

We've been investing in the resource universe for sometime now and been able to uncover plenty of good opportunities both in the US and abroad. As a result, the profits have been substantial. 

By Yiannis G. Mostrous
Editor: Silk Road Investor, Growth Engines

Yiannis G. Mostrous is an associate editor of Personal Finance . He's editor of The Silk Road Investor , a financial advisory devoted to explaining the most profitable facets of emerging global economies, and Growth Engines , a free e-zine that provides regular updates on global markets. He's also an author of The Silk Road To Riches: How You Can Profit By Investing In Asia's Newfound Prosperity .

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