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Could a Bottom Before Growing Season Leave Fertilizers Room to Grow?

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Stocks like Potash and Mosaic appear to be forming a bottom.

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MINYANVILLE ORIGINAL I've held off quite a while from pursuing my investment dream that a secular bull market for foodstuffs, corn, wheat, and soybeans in particular, will provide one of the great bull markets in the fertilizer space. In the coming years companies such as Potash (POT), Mosaic (MOS), and CF Industries (CF) will be the providers the fuel, as it were, to boost yields on diminishingly arable land.

What Have You Eaten for Me Lately?

Admittedly, the sector has seen some hitches over the past year. Issues of pink slime and mad cow have not helped volume of late; remember, most corn and soybeans are grown to feed cattle.

As well, mostly phenomenal weather across the US and South America has supported steady and abundant crops, lessening the need for yield-boosting phosphates.

Shares of several soft commodities such as corn, coffee, and cattle have recently hit 18-month lows, and are off anywhere from 25% to 65% from August 2011 peaks, as measured by PowerShares Ag (DBA). This price compression is also seen in the share price of the fertilizer names such as those above, with the notable exception being CF Industries, which stands near a 52-week high.

As an options trader, it's hard for me to strap on a position that will truly be part of a supercycle of capture-the-hockey-stick growth I expect in coming years, but I think that over the next few months, at least, these names are due for a rally.

Fundamentally, the industry is out of favor making valuations attractive. The sector is trading at just 10.5-times forward earnings, which is a four-year low. Dividends are minimal, typically less than 1%, but at least in place, and revenue growth is projected 16% for the balance of 2012. To be sure fertilizers are are known as relatively high beta stocks, moving quickly to both the upside and the downside.

And for good reason. Weather and input costs have a huge impact on revenues and margins. Right now both are lining up to deliver upside. In making phosphate, the largest input cost is natural gas. It is at its lowest level in 20 years, and any firm that has not locked in a favorable hedge should be have their tassel shorn. Weather has always been a wild card and should be viewed as something that reverts to the mean. Too much rain could force farmers to replant and move to a shorter cycle crop that consumes more fertilizer. This would give Potash, Mosaic, et al pricing power.

Technically Speaking

The stocks in question seem pretty washed out and appear to be forming a bottom. I like the support that Mosaic presents near the 48 level as it has now re-captured the 20-day moving average.

I'm setting up a bullish calendar spread in Mosaic to take advantage of a rally through June. For specifics, check out my OptionSmith newsletter.

For more from Steve Smith, take a FREE 14-day trial to OptionSmith and get his specific options trades emailed to you along with exclusive access to his full portfolio. Learn more.

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No positions in stocks mentioned.

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