What inventory levels tell us
Inventory levels reflect current industry supply and demand balance and safety stock. When inventory levels rise, they’re often a negative sign, as they suggest industry demand is cooling. While manufacturers can adjust to the weaker demand by cutting production, they often lag. But when inventory reaches a certain level, it will usually fall as cyclical demand returns or the pace of production cuts begins to outpace falling demand.
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Potash inventory rises in July
On July 31, potash inventory in North America stood at 3.00 million metric tonnes, which was an increase from June’s 2.91 million metric tonnes. Inventory levels have been falling since the beginning of the year, as high corn prices had encouraged strong farmer purchases, which has supported revenues of fertilizer companies like Potash Corp. (POT). The decline has followed a period of increase since mid-2011 as global food inflation cooled and economic growth fell, resulting in lower demand from Chinese and Indian farmers.
Lower purchases due to lower demand likely
The recent rise in potash inventory reflects higher production than what farmers demanded. With the recent fall in corn prices, inventory levels could climb higher or stay elevated for some time, which means weaker revenue for potash companies in the short term. But potash inventory has historically peaked at ~3.2 million metric tonnes, likely reflecting the cyclical nature of potash demand and production cuts.
Unlike they do with nitrogenous fertilizers, farmers don’t need to apply potash every year because the nutrient applies to the soil and isn’t directly consumed by crops. From 2005 to 2008, inventory fell as farmers demanded more potash to take advantage of high crop prices. From 2008 to 2009, inventory rose sharply as crop prices collapsed due to lower economic activity, which made potash use less attractive.
Potash producers like Potash Corp. (POT), Agrium Inc. (AGU), Mosaic Co. (MOS), and Intrepid Potash Inc. (IPI) could be negatively affected in the short to medium term by higher inventory, even though these companies should see better performance in the future. The question is, when? This will also impact the VanEck Vectors Agribusiness ETF (MOO), which invests in every business stage within agriculture industry’s supply chain.
© 2013 Market Realist, Inc.