Can disruptions to fertilizer, aluminum supply impact global markets as well?
The closure of the Strait of Hormuz is, first and foremost, an energy supply story. The statistics have been repeated ad-nauseum, that more than 20 per cent of global oil and 25 per cent of global liquefied natural gas (LNG) is shipped through that tiny waterway now under severe restriction. That volume of energy is enough to stall global economic growth if this conflict is prolonged. But hydrocarbons are not the only key economic input now constrained by conflict.
Fertilizer flows from the Arabian Gulf in huge volumes, too. Saudi Arabia exports 25 per cent of the world’s phosphate fertilizer, the Gulf region exports 40 per cent of the world’s sulphur, and around 30 per cent of global urea trade is being held behind the Strait. Gulf Cooperation Council nations also supply around 9 per cent of global aluminium supplies, and Iran has already targeted smelting facilities in its strikes against Gulf targets. While headline risks to portfolios are largely being driven by restrictions to oil and natural gas, these other key inputs offer a different dynamic that advisors may want to consider.
“I think of this as the domino effect that goes in multiple directions, it’s not just a simple linear impact,” says Lorne Gavsie, SVP and Head of Macroeconomic & FX Strategy at CI Global Asset Management. “I think the right way to frame this is to think about selective stress points, not a blanket supply shock, especially on the fertilizer side… The reality is that a lot of fertilizer production is done on a regional basis. But we don’t necessarily hear about the fact that fertilizer production in certain regions is highly dependent on natural gas that comes through the Strait of Hormuz.”
Gavsie notes that fertilizer can actually be viewed as an energy input, and that aluminium remains a key commodity in ongoing electrification efforts around the world. He sees the economic impacts of these supply issues as compounding the supply shocks to oil and natural gas and highlights the ongoing fiscal responses in certain regions as a likely ongoing trend.
Farmers, he says, are under severe pressure now in much of the world as fertilizer prices rise. Certain fertilizers, such as potash, are more plentiful now as their supply comes largely from Canada and Russia. Potash, however, is a source of potassium, rather than the nitrogen and phosphorous that farmers get from the Gulf. Gavsie speculates that this may change what farmers plant this year, focusing on crops that require less nitrogen and phosphorous and more potassium. There could also be broad pressure placed on food systems as farmers produce less of what consumers want, or less food overall.
While Gavsie sees this impact on farmers and food supply as challenging, he doesn’t expect a full-blown food shortage crisis. He notes that many of the larger food-producing regions in the midst of planting season right now, especially in North America and Europe, don’t get their fertilizers from the Gulf. The regionally dispersed nature of fertilizer supplies may be softening this particular blow somewhat. He also notes that fiscal responses from governments to support farmers and secure food supplies are likely if food production meaningfully deteriorates.
From an investor’s perspective, global constraints to fertilizer and aluminium supplies seem to benefit Canadian producers. Gavsie notes, however, that much of that benefit has already been priced in, just as it has with Canadian energy names. An immediate end to hostilities and reopening of the Strait of Hormuz would still need to be followed by the restoration of Gulf production, which could take years. However, Gavsie still believes that there could be risk in some Canadian fertilizer or aluminium producers, as well as energy stocks, when markets get certainty that Gulf supplies will come back online.
Even if the future runway for Canadian producers may be less clear, Gavsie argues that the home bias that many Canadian investors already hold in their portfolios has likely seen them participate positively in the pricing in of supply shortages. That Canadian exposure has been a healthy hedge against risks in the Middle East and Gavsie says there’s an opportunity for advisors to frame these risks to key global inputs not just as a source of fear, but a reminder of what benefits diversification can bring.
“I would frame it as a positive in the sense that it’s a protection to the portfolio. There’s going to be other sectors within a portfolio that are exposed. Not every sector, just because it’s Canadian is going to outperform rest of world. We’re still susceptible to the global themes and sectoral winners and losers,” Gavsie says. “But at the end of the day having some counterbalance, or what we like to call is portfolio diversification, particularly because of the Canadian backdrop, is a net positive for portfolios on a relative basis.”
