This is, of course, exactly what you’d expect to see at or near a major market bottom. But we do have a note of caution for those trying to bottom tick or buy at the absolute low point: Even the pros will tell you they’ve only done it a handful of times and that luck played a major role.

One of the features of this service over the past year has been the commentary of one of those pros: George Kleinman, a successful commodities trader for more than 30 years. His comments have been emailed to Vital Resource Investor readers as the free e-zine Commodity Trends.

George has a slightly different perspective from us. He’s dealing in the fast-moving markets of the raw materials themselves, whereas we’re focused squarely on individual stocks. Just as moves in the S&P 500 and other broad stock market averages anticipate the overall economy, so do moves in resource stocks presage moves in the prices of the resources themselves.

On the other hand, just as a bottom for the broad stock market always precedes a bottom for the economy, so does a bottom for resource stocks tend to occur before commodity prices themselves bottom. As a result, any indication that commodity prices are reaching a bottom is a pretty good sign that we’ve seen the bottom for resource stocks and that a leveraged recovery is about to begin in earnest.

Our goal right now is to ensure we’re in the right positions to take advantage of this recovery. For those who have been in this market for a while, it will mean recovering the past year’s losses and then some. For those now picking through the wreckage for bargains, it will be nothing but upside.

The price of building or maintaining positions now, however, is the risk that things could well go lower in the near term for commodity prices themselves. That may not be enough to take prices of the shares significantly lower from here, given that Rio Tinto trading at barely 4 times earnings and Freeport–McMoRan Copper & Gold is only about 3 times trailing results. But no one should expect a recovery to get off the ground in the stocks until the raw materials themselves have bottomed.

When can we expect to see that? This week George had these comments:

This morning it was announced the Treasury has now dropped their plan to
buy mortgages, the cornerstone of their $700 billion rescue package. It is
good Paulson realized his mistake, but this reversal does seem to further
underscore they do not seem to know what they are doing at Treasury.

Turning to commodities, many are undervalued right now. Corn, cotton, and
others are trading under the cost of production. I would like for us to be
buyers of markets like soybeans right now (it remains too dry in South
America for their newly planted crop), but as long as the sentiment in the
outside (particularly the stock) markets is so bearish and so deflationary
and as long as the dollar continues to rally it makes more sense to remain
on the sidelines. There will be a time, we stay patient.

Again, George is buying commodities through futures where absolute timing is everything. That’s a different proposition from building a portfolio of what are now extremely cheap stocks that are poised to turn on a dime when these raw materials do.

George’s point that these commodities are deeply undervalued is a pretty compelling indication of just how explosive the recovery might be. So is his read that it’s deflationary sentiment that’s the primary obstacle to getting that recovery underway.

The upshot, though, is that this is a time for patience. We want to establish positions in good companies now, but we have to give them enough time for the big picture to play out. If we do, the next year is going to be every bit as profitable for us as the last six months were devastating.

Canpotex, a distribution company and the world’s largest exporter of potash owned by Potash Corp (NYSE: POT), Agrium Inc. and The Mosaic Company, recently announced the conclusion of its potash deal with Japan for 1H09 at higher prices.

The contracts call for a price increase of USD200 to USD220 (depending on grade) per ton, bringing the average equivalent delivered price to Japan to more than USD900 per ton. The current spot price for potash is between USD900 to USD1000 per ton, indicating that there’s still pricing power in the business even when urea and phosphate prices keep falling.

The high concentration of potash production to a few big players and the tight potash capacity seem to be the key reasons behind the ability to raise contract prices.

The implications are that potash producers will have a good precedent when they start negotiations with China later this month. Higher prices can’t be ruled out either, especially since the new stimulus package announced by the Chinese government calls for agriculture support with money passed onto farmers.

Furthermore, labor disputes between potash and its workers as well as infrastructure failures in Russia can also add to supply issues, further depressing the negotiating power of consumers. The current potash prices in China are at around USD640 per ton.

Given the price weakness in the resource sector and the constant downgrading of demand projections, potash pricing strength does come as a great positive piece of information. We continue to think that portfolio holding Potash Corp will be one of the best performing companies in our cover universe. See VRI, 9 October 2008, Buying Agriculture.

The stock was added to the VRI model portfolio in early October, and although it’s down around 20 percent since then, we still view it as a good holding on the agricultural theme.

Change in the Favorite Five

We’re adding Potash Corp to our Fab Five list because now’s a good opportunity to buy the stock. It will replace Monsanto (NYSE: MON). We still like Monsanto, but given the recent developments in the fertilizer industry, Potash Corp seems to be the better play right now. Monsanto will remain in the VRI portfolio. See VRI, 16 October 2008, Five to Buy Now.

Potash Corp (NYSE: POT) is the world’s largest and lowest-cost publicly traded potash producer, the fastest-growing segment in the fertilizer business. Its potash reserves are sufficient for more than 100 years of production. The company controls about 70 percent of the world’s excess capacity. Potash Corp is also the world’s third-largest phosphate producer and fourth-largest nitrogen producer.

Potash Corp has historically been a strong cash flow-generating company that used its cash to consolidate its position through outright acquisitions and by taking substantial stakes in other companies around the world. Buy Potash Corp at current prices.

China Green Holdings (Hong Kong: 904, OTC: CIGEF) is a China-based producer and supplier of fresh produce, processed and pickled products, branded food and beverage, rice and rice flour products.

Switzerland-based Xstrata (UK: XTA; OTC: XSRAF) is the world’s fourth-largest copper producer. It also has substantial positions in nickel, thermal and metallurgical coal, zinc, aluminum and an alloys division for chrome, vanadium and platinum group metals.

UK-based Rio Tinto (NYSE: RTP) is the world’s second-largest mining with operations in Australia, Africa, the Americas, Europe and Central/Southeast Asia. Rio Tinto is the world’s largest producer of aluminum, second largest producer of iron ore and a top five producer of alumina, uranium, mined copper, thermal and coking coal and diamonds.

Vale (NYSE: RIO) is one of the world’s largest miners of iron ore and nickel. The 2005 acquisition of Inco, a Canadian nickel producer, initiated Vale’s transformation from a Brazilian iron ore miner into a global player, with assets and operations on six continents.

Canada-based Sino-Forest Corp (TSX: TRE, OTC: SNOFF) is one of the biggest foreign forest operators in China, with plantations located in the East and South of the country. China’s first foreign and private forestry concern, it’s been in the country since 1994 and controls 6 percent of China’s industrial wood fiber market with operations in 10 provinces.

Sino-Forest’s businesses include the leasing and management of forestry plantations, sales of standing timber, wood chips, and logs and manufacturing of wood products (e.g., wood flooring). Business is highly seasonal, with 60 percent of total revenue coming in the third and fourth calendar quarters. Wood fiber operations are the main revenue contributor accounting for 93 percent of revenue.

In China, plantation lands are usually owned by the state and are managed by the regional forestry bureaus in a wholly- or collectively-controlled manner. The forestry bureaus allocate annual logging quotas. Sino-Forest is an exception, typically owning the trees where it manages the lands.

The company reported solid revenue growth in its third quarter, up 83 percent from the same period last year to USD295.5 million, pushing gross profit up 81 percent to USD127.6 million.

Those earnings make Sino one of the strongest forestry operations in the world, with most others facing falling demand for timber and the associated loss of revenue. Sino-Forest has benefited from the fact that is business remains largely in China, which hasn’t been badly affected by global economic woes, where wood fiber demand has remained steady from both the construction and furniture industries. Demand has been so strong that Sino-Forest also imported logs to help meet demand, and revenues from those activities jumped 137.5 percent to USD13.4 million from the same period last year.

The only fly in the ointment from an earnings standpoint was a USD18.2 million impairment charge in the quarter, taken against a write-down of some of its manufacturing facilities to fair market value because of higher input costs. However, Sino-Forest has established cost-control measures and has said that if there’s no improvement, it’s willing to sell the facilities.

Overall, net income rose 18.6 percent to USD75.2 million, though with the impairment charge, net profit margin fell 39.3 percent. With a cost-control plan in place and continued strong Asian demand for wood fiber products, Sino-Forest remains a buy.

Australia-based Paladin Energy (Australia: PDN; OTC: PALAF) is a pure play uranium producer with a strong portfolio of developed assets and developing properties both Down Under and in southern Africa. The company has one mine in production, Langer Heinrich in Namibia, one that will be starting output early next year and six more that are in various planning stages.

Its relatively new production status is the company’s main advantage: It’s not locked into long-term contracts as its more established peers are, so it can benefit from the stronger uranium prices–especially if our assessment that uranium prices have bottomed out is correct.

In Paladin’s first quarter report released earlier this week, it reported that production at its Namibian mine increased to 650,554 pounds of uranium, representing annualized production of 2.6 million pounds. That puts the mine’s production about 500 pounds over production and will be a key benefit to the company given that many of its larger competitors have reported reduced production due to financing and operational issues. Despite that, uranium demand remains high, giving Paladin unique pricing power.

The company’s Kayelekera mine in Malawi is also on track for production ramp up in March, with the project on schedule and on budget, which will be a key benefit in the second half of the year. With reserves of more than 25 million pounds of ore and a long-term contract signed to supply a major, though unnamed, Asian utility, the new mine should begin making a major contribution to cash flows in the third quarter.

Shares have sold off post-earnings given the reported USD4.7 million quarterly loss, but that’s largely attributable to exploration and development expenses. Given the results being yielded, that’s a perfectly acceptable loss. Continue buying Paladin Energy at current prices.