With oil off more than 20% from its July peak, and the Reuters-CRB Continuous Commodity Index down 19% from its June high, traders are betting that commodities have entered a bear cycle with much further to fall. But it is much more likely that commodities will enjoy another “bounce,” with many of them revisiting record levels before a true downturn sets in.

Smart investors will take advantage of this bounce.

In the long run, commodities prices are likely to deflate. Even for oil, new supplies exist and are economic at prices well below those currently prevailing. For agricultural and other “soft” commodities, it’s mostly a matter of planting new land and waiting for the crop.

However, rapid international growth for several years can cause demand to run ahead of supply, and this causes prices to “spike.”  Once this has happened, a sustained period of below-par growth is necessary in order for commodity supply to catch up with newfound demand.

The most important factor regulating international demand is the overall level of interest rates in terms of inflation. If “real” interest rates – netting out the rate of inflation – are high as in the 1980s, demand growth is sluggish (because the cost of capital to make new investments is high) and so commodity prices are generally low. Conversely, low real interest rates and surging inflation, such as occurred in 1973, can cause the prices of all commodities to spike upwards.

While there are signs of global demand slowing, it is nowhere near stalling. The International Monetary Fund (IMF) expects world gross domestic product (GDP) growth of 4.1% in 2008 and 3.9% in 2009. Those rates compare with growth rates of 5% or just over in 2006 and 2007. However, they are still sufficient to put considerable pressure on commodity supplies, which are already stretched by current demand.

To reduce commodity demand, and produce a real drop in prices, global interest rates would have to rise sharply. Currently, short-term interest rates are negative in real terms (below the local rate of inflation) in the United States, the European Union and Japan, and only just positive in the United Kingdom.

They are also sharply negative in India and many emerging markets and likely to become so in China, where official inflation has been suppressed pre-Olympics. With negative real interest rates prevailing almost everywhere, the global trend must be one of firm demand and accelerating inflation.

Eventually, the United States, which tends to lead the international community in interest rate matters, will be forced by accelerating inflation to increase sharply its short term interest rates – the 2% Federal Funds rate is now more than 3% below consumer price inflation (CPI) and more than 5% below producer price inflation (PPI). When that happens, other countries will follow and the commodities boom will deflate.

However, it won’t happen just yet because of the housing crisis. U.S. Federal Reserve Chairman Ben S. Bernanke wants to see home prices come to some kind of equilibrium before raising interest rates, otherwise he could produce an uncontrollable fall in house prices, causing more or less the whole U.S. home-mortgage market to default.

Since interest rates are likely to remain low for several months at least, commodity prices are likely to “bounce,” rather than remaining in a bear market. Speculative capital, of which there is still plenty, will then rush back into commodities, pushing prices up still further.

Of the various commodities, agricultural commodities are the least likely to bounce substantially, because the supply cycle is relatively short and high prices are already causing new planting. Shipping rates are also fairly unlikely to soar, as new building has been undertaken at a frantic pace in the past few years and capacity is now coming on stream.

On the other hand, metals and energy, for which finding new sources is a lengthier process, are more likely to bounce, particularly if geopolitical uncertainty continues to increase in the aftermath of the Georgia invasion.

The most upwardly mobile commodities are likely to be those whose movements are directly related to inflation – gold and silver. Gold, in particular, is one of very few commodities whose price is currently within a few percent of that last September, when Bernanke & Co. began cutting interest rates. 

While the equivalent in real terms of 1980’s $850 peak in the gold price may be unattainable – that would require gold to reach $2,300 – a $1,500 price for gold certainly seems possible.

I would recommend consideration of StreetTracks Gold shares (GLD) about the most efficient way of getting a pure gold play. As an alternative, you might consider a silver investment – the metal is currently at less than 15% of its 1980 high equivalent to $130 per ounce – the iShares Silver Trust ETF (SLV) seems the best way to play silver directly.

You may do even better in gold mining shares. The recent declines in the gold price have caused a huge amount of air to whoosh out of gold share prices, to the extent that they now represent pretty good value.

• Barrick Gold Corp. (ABX) is a Canadian company, with mostly North American production, plus some in South America and Africa, and copper and zinc add-ons. With a market capitalization of $29 billion, this firm has plenty of liquidity. It has a trailing Price/Earnings (P/E) ratio (on last 12 months earnings) of 15, and a forward P/E (on next 12 months) of 13. The stock is reasonably valued and has little political risk.

• Newmont Mining Corp. (NEM) is a U.S. company, operating in the United States, Australia, Peru, Indonesia, Ghana, Canada, Bolivia, New Zealand and Mexico. It also has low political risk, but with a $19 billion market capitalization, trailing P/E of 25 and forward P/E of 14, Barrick still looks like a better value.

• Yamana Gold Inc. (AUY) is a Canadian company with mining in Brazil, Argentina, Chile, Honduras and Nicaragua.  It has a market capitalization of $7 billion and a trailing P/E of 33, but a forward P/E of only 10. There’s medium political risk, but the firm expects to double production to 2.2 million ounces per year by 2012, primarily in Brazil and Argentina.

• Gold Fields Ltd. (GFI) is a South African company with mining operations in South Africa, Ghana, Australia and Venezuela (of which they recently sold control to a local company). With a market capitalization of $5.7 billion, trailing P/E of 11 and forward P/E of 10, this firm is an upper-medium political risk, depending on what you think of South Africa. However, its shares have fallen a lot and are now cheap.

News and Related Story Links:

• Money Morning:

Six Ways to Play Money Morning’s Prediction That Gold is Headed for $1,500 an Ounce

• Money Morning:

Don’t Let the Market’s Juke Move Fake You Out of the Looming Profits in Gold

• Money Morning:

Silver Prices Ready to Rocket; Four Reasons Why and Two Ways to Buy

By Jason Simpkins
Associate Editor

Editor’s Note: This is the seventh installment of a new Money Morning series highlighting investment opportunities in the global bull market for commodities.

When it comes to the worldwide metals market, gold may get all of the attention but other, more durable, metals such as steel and iron have proved to be much more profitable. For instance, the price of gold is actually down 2% from mid-January, but steel prices are 50% higher.

Hot-rolled steel, the industry benchmark, has jumped from $600 per metric ton in January to about $1,000 per metric to today. And in the United States, steel for July delivery has doubled to $1,200 a metric ton.

Steel stocks tracked by the Market Vectors Steel (SLX) exchange-traded fund (ETF) are up more than 50% in the past year and 22% this year-to-date. That’s substantially better than the Market Vectors Gold Miners (GDX) ETF, which is up only 13% in the past 12 months, and is actually down more than 3.5% year-to-date.

Without question, steel’s practicality gives it a decided edge. Demand for steel has risen exponentially as such emerging countries as China and India create the infrastructure that ultimately will house, transport and service the largest and wealthiest populations on the planet.

Some analysts are beginning to worry that as economic conditions in the world’s most developed countries weaken, so too will the demand for steel. But according to the Organization for Economic Cooperation and Development (OECD), emerging markets are ready to pick up the slack.

“Global steel demand growth continues to be led by emerging economies to meet the requirements of expanding industrial sectors and infrastructure growth,” Risaburo Nezu, chairman of the OECD steel committee, told Forbes. “Demand in many mature economies has slowed in line with weaker economic activity.”

The OECD’s steel committee consists of industry and government officials from countries that together account for 81% of the world’s steel exports.

And according to Nezu, steel use continues to grow most rapidly in the so-called “BRIC” economies of Brazil, Russia, India, and China. In 2007, steel use rose:

• 18.6% in Brazil
• 13.5% in Russia
• 11.3% in India
• 13% in China

All told, those four countries found uses for 521 metric tons of steel, with China accounting for 78% of that total. Demand in Africa and the Middle East has surged, as well.

For one key Middle East nation – Saudi Arabia, the world’s largest oil producer and exporter – oil prices above $130 per barrel have resulted in a veritable “golden age.” Now the Saudi kingdom is putting some of its awesome wealth to use by embarking upon a $460 billion construction program. According to the National Commercial Bank (NCB) Saudi Arabia has formally announced 576 separate projects, 70% of which are already well advanced.

“These investments are inspired by the Kingdom’s ambitious strategy to tackle the country’s most chronic social and economic challenges; rising unemployment and the need to create more than five million new jobs by the year 2020, declining living standards and overall wealth of the population, and the unbalanced regional economic development,” the NCB told Emirates Business.

In fact, as Emirates Business reported, Saudi Arabia has opted to curb steel exports to its Gulf neighbors after soaring demand resulted in shortages that left the nation unable to complete its own slate of massive building projects.

Facing a similar plight, India also has been forced to curb steel exports, as domestic demand continues to outstrip the country’s production. While demand is expected to grow by 12% a year, the production is growing at only half that rate. Consequently, India was forced to issue export taxes on its own domestic steel industry. The government has levied a 15% tax on the export of hot rolled coils, a 10% tax on the export of cold rolled steel, and a 5% tax on galvanized steel, The Economic Times reported.

As demand soars and supplies tighten throughout the developing world, analysts are beginning to take note and are bumping up their predictions for where steel prices are headed in the years to come.

Goldman Sachs Group Inc. (GS) has already boosted its projected price for steel to $936 a ton for this year, and expects the price will hit $1,000 a ton in 2009. Compare that to fourth-quarter steel prices, which averaged just over $530 a ton, and it’s plain to see that steelmakers are in prime position for record profits.

Here are a few companies to consider:

United States Steel Corp. (X): U.S. Steel is spearheading a revival in the domestic steel industry. About 30 U.S.-based steel mills were shut down between 2001 and 2003 as a strong dollar and cheap foreign labor squeezed the American steel industry. But industry-wide consolidation has reduced production costs and a weak dollar has made U.S.-made steel more appealing to hungry foreign markets.

U.S. Steel shares are up about 46% year-to-date, and are up more than 1,025% from their 2003 levels. Analysts at Deutsche Bank Securities (ADR: DB) just reiterated their “Buy” rating on the stock, while raising their target price from $165 to $220 a share.

Posco (ADR: PKX): Posco is Korea’s largest steel company, and its shares are trading at 12 times estimated 2008 earnings. It also features a dividend yield of 1.9%. Posco has a large export operation to China, making it a key participant in China’s explosive growth.

Although it’s the world’s third-largest steelmaker, it’s the most efficient in terms of output per man-hour. Posco suffers from the rising prices of raw materials; in its case iron ore business, for instance, it was recently socked with a 65% price increase.

Even so, as we’ve previously reported to you, let’s not forget that when Berkshire Hathaway Inc. (BRK.A, BRK.B) Chairman Warren Buffett made his first investment foray into Korea last year, he took a 4% position in Posco – making it one of 20 Korean companies that he invested in. Posco is a well-run company that will become even more attractive should the commodities bubble deflate.

The Companies Fueling Asia’s Steelmaking Industry

Steel is in high demand, but it can’t be manufactured without iron ore, its key ingredient. For that reason, the price of iron ore has risen sharply in lockstep with steel, soaring 50% since January. Rising steel demand – especially in China – has been the key catalyst behind the price jump and now iron ore producers are looking to take advantage.

The world’s largest iron ore producer, Brazil’s Vale (ADR: RIO), has already cashed in, boosting prices by 65% to 71%.

However, Rio Tinto PLC (ADR: RTP) and BHP Billiton Ltd. (ADR: BHP) think they can do better. Both Rio and rival BHP are currently in negotiations with China’s steelmakers, and are believed to be pushing for an 85% increase in 2008-2009 benchmark iron ore prices.

That’s because the two Aussie juggernauts believe their proximity to Asian markets entitles them to a freight premium. Freight accounts for 30% of the landed cost of Australian iron ore in China, but close to 50% of the price of Brazilian iron ore. The Australian miners want some of the difference to go into their corporate coffers.

China – which is the world’s largest steel producer and its largest steel consumer -imported 383 million metric tons of iron ore in 2007, an increase of 56.8 million tons, or 17.4%, from the previous year, according to the China Iron and Steel Association.

At some point, China and other emerging countries in the East are going to have to succumb to the demands of BHP and Rio by paying a premium for their proximity.

Both Chinese steelmakers, headed by Baosteel Group Corp., and the miners expect to have a deal done by June 30.
“This has never really ever happened before,” James Wilson of DJ Carmichael & Co. in Perth, Australia, told Reuters. “But the prices also have never been this high before, and the Aussies have never before demanded this much.”

Merrill Lynch & Co. Inc. (MER) recently boosted its long-term iron-ore-price forecasts by 30% on the back of tightening market conditions. So both Rio Tinto and BHP stand to profit handsomely as the middlemen for Asia-Pacific iron-ore demand.

Not to be outdone by Australia, Brazil recently announced a $27 billion plan to double its iron ore production, Australia’s Herald Sun newspaper reported.  Paulo Camillo Penna, president of the Brazilian mining institute, said investment would be driven from 350 million metric tons to 650 million metric tons over the next four years. By comparison Australia’s projected production of 489 million metric tons in 2012-2013.

This should bode well for Vale, the world’s leading iron ore producer.

Durable, Lightweight, and Profitable

Aluminum, like iron ore, is a very useful metal – and not just for beer and soda cans. With its very light weight and low density, aluminum is often the first choice for long-distance power lines. And buildings made with aluminum are virtually maintenance free, due to the aluminum’s resistance to corrosion.

The metal also is ideal for the transport industry, which is actually moving away from heavier steel. At a time when fuel efficiency has been pushed into the spotlight by soaring gas prices and growing apprehension over global climate change, aluminum is poised to make a big difference in the transportation sector – particularly the automotive industry.

On May 30, in fact, the U.S. Environmental Protection Agency (EPA) repealed an obscure clean water regulation that restricted the use of aluminum in automobiles. The restriction was driving up the cost of aluminum car parts by forcing manufacturers to use expensive clean-up systems, Forbes Magazine reported. In effect, the May 30 amendment has made aluminum car parts into a cheaper alternative, and that will accelerate industry plans to replace the large amounts of steel currently being used.

Aluminum could reduce the weight of cars substantially, as it weighs roughly half as much as steel does. With every 10% reduction in weight, fuel consumption declines by 6% to 8%, Forbes reported.

The aluminum industry claims that every pound of aluminum used in a car reduces carbon-dioxide emissions by 20 pounds over a hundred miles.

“Fifteen million aluminum-intensive vehicles containing 250 pounds of aluminum would: save 3.5 billion gallons of gasoline [and] reduce CO2 emissions by 37.5 million tons,” according to a lobbying document.

Aluminum figures to be a key component in increasing fuel efficiency in everything from automobiles to airplanes. But as demand spirals, supply concerns escalate in kind.  Despite the consensus bet that aluminum prices would fall in 2008, they have climbed, soaring 25% since January – mostly due to rising production costs and dwindling supplies.

Goldman Sachs, UBS AG (ADR: UBS), Lehman Bros. Holdings Inc. (LEH), and Citigroup Inc. (C) each have raised their price forecasts for aluminum. Most recently Deutsche Bank raised its forecasts from this year through 2012 by 8%-13% as oil hit a string of record highs over $100 a barrel.

Energy accounts for 40% of the cost of aluminum smelting, compared to 30% last year, Barclays Capital (ADR: BCS) reported. And demand for aluminum is rising 6% annually.

Six new smelters will need to be built each year to keep up with demand, Gayle Berry, an analyst with Barclays told Bloomberg.

Alcoa Inc. (AA) is the world’s largest aluminum company, and according to The Wall Street Journal, its prospects look good because of improving fundamentals in the aluminum market and the company’s takeover appeal.

John Hill, a mining analyst at Citigroup, thinks that aluminum prices, now around $1.30 a pound, could hit $2 in 2009, the newspaper reported. As a result, Alcoa’s earnings could rise to nearly $5 a share in 2009, from an estimated $3 this year.

Alcoa’s shares are currently trading at nearly $40 each, up nearly 10% on the year. The shares feature a dividend yield of more than 1.7%.

[Editor's Note: Money Morning's "Cashing in on Commodities" series last covered gold. Next up: Are high commodity prices fueling global takeovers? What are the top profit plays investors should consider?]

News and Related Story Links:

• Emirates Business:
  Saudi cuts steel exports to Gulf neighbours after surge in demand 

• Economic Times:
  Govt to impose 15 pc export duty on iron ore

• Washington Post:
  U.S. Steel Industry On Rebound

• U.S. News & World Report:
  4 Steel Stocks to Strengthen a Portfolio

• Forbes:
  Best Bets in Soaring Steel Stocks

• Herald Sun:
  Brazil to double iron ore output

• Money Morning:
  Iron Ore Proves to be the Most Coveted Commodity in the Pacific

• Money Morning:
  Rio Tinto Wants More For Its Iron Ore

• Forbes:
  Why Aluminum May Glow Like Gold

• Bloomberg:
  Aluminum Traders Expect Output Costs to Rise Until 2013 on Oil

• Wall Street Journal:
  Alcoa to Enjoy Rising Prices, Demand and Takeover Interest.

• Money Morning Commodities Investing Report:
  
  Cashing in on Commodities: Will Gold Hit $1,500 an Ounce? 

Editor’s Note: This is the fifth installment of a new Money Morning series highlighting investment opportunities in the global bull market in commodities.

By Jennifer Yousfi
Managing Editor

Soaring prices of grains, dairy and meat have been grabbing global headlines. But other commodities have been on the rise as well. I’m not talking about the increases in daily staples that make the front page, but those little extras that make daily life just a little bit sweeter – coffee, cocoa and sugar.

We might not need them, but we definitely want them. And inflation is putting upward pressure on the price of these soft commodities just as it is on oil and grains such as wheat and rice.

Coffee is Big Business

It doesn’t take an investment expert to realize Americans love their coffee. It’s no longer a drink just to wake you up in the morning. Starbucks Corp. (SBUX) helped create a cultural coffee phenomenon, introducing consumers to espresso drinks. Now it seems like every city street corner has its own gourmet coffee shop selling specialty coffee beverages, often for upwards of $4 a cup.

But it’s not just the extra foam on top that is making that cup of coffee cost more. The price of coffee beans has more than doubled in the past few years.

According to U.S. Department of Agriculture (USDA) data, the New York spot price for Brazil’s Arabica coffee is up 20% over last year’s annual average of 110.72 cents per pound. Just five years ago in 2003, the annual average was only 50.82 cents per pound.

The USDA said in its recent Tropical Products: World Markets and Trade report that U.S. imports of coffee and coffee products increased 14% in 2007 to $3.8 billion. Meanwhile, exports were at a record $513 million, but that’s still a huge trade imbalance. 

But there’s hope for those who are looking for a cheap cup of joe before year-end. Brazil’s 2008 coffee crop is just starting to be harvested and is already forecast to be one of the best ever, producing almost 50 million bags of coffee.

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“With Brazil’s larger production this year, world coffee output is expected to reach 133.25 million bags while consumption is seen at 126.0 million. If these figures are realized, it will result in an 8.25 million-bag surplus for the 2008 crop year,” wrote James Cordier & Michael Gross, Optionetics.com. “This is not a record surplus, but it should be enough to knock prices down into a new trading range for the second half of the year.”

If coffee prices head lower this year, then the buyers of the raw beans are going to be the ones to benefit. You might want to consider:

• Green Mountain Coffee Roasters Inc. (GMCR): The bulk of U.S. coffee exports are of the roasted variety and this company is getting its share of that export action. It recently announced expected sales growth of 42% to 47% for its fiscal third quarter and reaffirmed its positive outlook for the full-year. Year-to-date, shares are up just a little over 1%, but are up 35% over the past five years. Green Mountain also owns the popular Keurig single-cup brewing system and sells many varieties of coffee to fit it.

• Starbucks Corp. (SBUX) and McDonald’s Corp. (MCD): Starbucks will likely benefit from any dip in coffee prices. Meanwhile, McDonald’s has been aggressively entering the specialty coffee arena and is set to give Starbucks a run for its money when it comes to lattes and espressos served on the go.

The Cost of Cocoa

You may have noticed that your candy fix, much like your caffeine fix, has cost you more lately. On average, the cost of high-quality chocolate, which has a higher cocoa content, has increased over 6% in the last year, according to Nielsen data.

That’s because the cost of cocoa has more than doubled since the beginning of 2007. It can be shipped in powder, paste or liquid form and commands $2,600 per metric ton on New York’s Intercontinental Exchange, up from $1,700 at the start of 2007.

And while cocoa is certainly subject to the same conditions that can affect other crops such as poor weather conditions, the huge increase in price, at least for this commodity, doesn’t seem to be a simple function of supply and demand.

For the year ending in September, the International Cocoa Organization only expects a 51,000-metric-ton shortfall, which can be made up with existing stock, The Wall Street Journal reported.

“The fundamentals do not justify this price, and I haven’t heard of any other explanation other than [investment] funds,” said Hagen Streichert, a German government official and the spokesman for cocoa-buying countries on the International Cocoa Council.

Many analysts and management from some of the leading global chocolate manufacturing firms including Cadbury PLC (ADR: CBY) and the Swiss firm Chocoladefabriken Lindt & Spruengli AG are pointing the finger at hedge fund investments. Volatile equity markets and tight global credit markets have led funds to seek out alternative investments in commodities.

“In my lifetime, it’s an entirely new phenomenon,” Stephanie Garner, a cocoa trader for Sucden, a broker owned by Sucres & Denrees SA, on the London International Financial Futures and Options Exchange told The Journal, speaking of the sudden increase in cocoa futures contracts. “It’s to a large extent a fallout of the credit crunch.”

It’s hard for the average investor to find a pure cocoa play. There are some exchange-traded funds that focus on the price movements of cocoa, but they trade in London and aren’t open to most U.S. investors. However, Africa produces most of the world’s cocoa supply, so an ETF focused on that region could be a good choice:

• SPDR S&P Emerging Middle East & Africa ETF (GAF): This ETF seeks to replicate the movement of an equity index based on the Middle East and African equity markets. The fund uses a passive management strategy to track the total return of the S&P/Citigroup BMI Middle East & Africa index.

Sugar High

Most people take sugar on the table for granted, but soon it might be used for more than just sweetening your tea.

The USDA recently released its World Sugar Situation report for May 2008. The expected raw sugar production for the 2008-09 marketing year of 161.7 million tons will just barely meet estimated global usage of 160.8 million tons. Production is down 3.8 million tons, while consumption is up 4.6 million tons from the prior year.

But due to trade imbalances, the USDA estimates a 1.1 million ton shortfall in the 2008-09 marketing year.

“World sugar raw prices dramatically increased during the last six months reaching over 15 cents [per pound] in March before declining to present levels of under 11 cents [per pound],” the report read.

On its own, Brazil accounts for 20% of global sugar production. Asian countries account for 40%. Brazil, India, Thailand, and China, together, account for half of world production and 56% of world exports.

But if demand for ethanol continues to increase, as it likely will given current government production mandates, sugar could become even scarcer. Brazil uses sugar cane, rather than corn, which is favored in the United States, to produce the popular alternative fuel.

Imperial Sugar Co. (IPSU), one of the largest U.S. sugar refiners is currently planning the first ethanol plant that would run on a mix of corn and low-grade sugar. If approved, the plant could be up and running as soon as 2011.

If Imperial can find a way around government caps that currently limit how much sugar can be imported for non-food use, it could be very cost effective.

“It makes all the sense in the world,” State Representative Nick Lampson told The Houston Chronicle. “If you look at the world price of sugar, it’s less than 3 cents a pound. Our sugar price is about 19 cents a pound. That means we could produce energy for significantly less than what is presently being used to make ethanol from corn.”

With oil at record highs, cheaper ethanol could be set to become a very valuable commodity of its own. That could put upward pressure on the cost of sugar, especially if sugar becomes a cost-effective alternative to corn.

If you’re looking for some sweet profit plays, consider:

• iShares MSCI Brazil Index (EWZ): The largest South American country is one of the leading exporters of both coffee and sugar. This exchange-traded fund seeks to provide investment results that correspond generally to the price and yield performance of publicly traded securities in the Brazilian market as a whole, as measured by the MSCI Brazil Index.

• Imperial Sugar Co. (IPSU): Sometimes it pays to be first. And if Imperial can pull off its proposed hybrid ethanol plant, its profits could be set to take off. The stock is currently trading near its 52-week low of $13.83, but the firm has maintained its 7-cent quarterly dividend.

[Editor's Notes: In Money Morning's "Cashing in on Commodities" series we have written about uranium and coal, crude oil, timber and frontier markets. Next up: Look for our story on gold this Friday. While oil and other commodities have dominated the headlines, they're far from the only investment opportunities available. And some of the other profit plays are more lucrative, and less risky. If the economic uncertainty - or the volatile markets - of recent months have you at a loss over the best moves to make next, check out Money Morning's first book, "The Essential Investor's Playbook for the Next 12 Months." At 118 pages, our just-published global-investing guide provides an insider's look at the Top 16 global trends you're likely to face over the next year or more, and contains a special chart that details more than 50 profit opportunities. And it really is a playbook: No matter what the market throws at you, you'll find a play you can call to maximize profits.]

News and Related Story Links:

• The Wall Street Journal:
  Candy Companies Blame Higher Prices on Hedge Funds’ Chocolate Cravings

• The Houston Chronicle:
  Sugar may be stirred into the ethanol mix

• Optionetics.com:
  Commodities Roundup: Coffee

• Money Morning Commodities Investing Series:
  Cashing in on Commodities: The Short- and Long-Term Solutions to the Growing Global Energy Crisis.

• Money Morning Commodities Investing Series:
  Cashing in on Commodities: What’s Driving the Oil Bull, How Much Further It Will Go, and How Investors Can Profit.  

• Money Morning Commodities Investing Series:
  Cashing in on Commodities: Lumber & Paper Mills Struggle as Timber Stands Tall.

• Money Morning Commodities Investing Series:
  Cashing in on Commodities: Two Ways to Profit From the World’s Newest Markets

Editor’s Note: This is the fourth installment of a new Money Morning series highlighting investment opportunities in the global bull market in commodities.
By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Many people are in sticker shock thanks to high gas prices and oil that punched through the $135-a-barrel level recently, before sliding back.

And many investors are feeling left out because they haven’t been part of the incredible bull run energy companies have enjoyed in the last few years.

But have no fear.

It’s not too late to grab a piece of the pie.

The trick is that you’ll have to look beyond the obvious choices like major oil companies, drillers and other sectors that are hopelessly bid up right now. And you can play various types of funds, as well as stocks, as we’ll demonstrate.

The Four Factors Giving Life to the Commodity Bull

But before we tackle the how, let’s tackle the why:

• First, it’s important to understand that high oil prices are simply going to go higher, still. There will be inevitable pullbacks, but as we’ve written so many times in the past, the math is very simple – people are simply using more oil than at any time in history and worldwide demand is accelerating.

• Second, it’s also important to note that we haven’t had a major new discovery of any substantial size in the last 30 years. And by substantial, we mean big enough to change the balance of supply and demand and, by implication, to reverse the runaway increase in prices. The lack of any new discoveries, then, also points to higher prices.

• Third, absent an immediate, cost-effective and widely available substitute, oil is increasingly nationalistic in nature. This means that oil producers – and particularly the tyrants with spigots – will begin holding back production for their own use. That will reduce the supply available on world markets, further enhancing the upward pricing pressure.

• And fourth, while higher prices are finally inducing some drivers in modern industrialized countries to drive less, developing nations don’t give damn about conservation and are guzzling gasoline like there’s no tomorrow – which, for them, is entirely true. For these nations, access to energy and to petroleum is the literal equivalent to survival and they’ll do everything they can to ensure it. So any drop in demand we’re experiencing is almost immediately offset by higher consumption in such markets as China, India and many parts of South America. And that offsetting consumption may well persist for years.

That’s a very painful reality to face. But it does bring us to the fun part of this commentary: The profits.

New Markets = New Profit Opportunities

Any time you have sustained supply-and-demand imbalances, you also the potential for huge profits. And what’s happening now is no different.

Viewed in that light, higher oil prices can actually be a good thing for the stock markets, just as the rising price of such “commodities” as gold, copper, cotton, silk and spices have been for various nations since the dawn of time.

The reason is that excess profits that would ordinarily flow to Caracas, Moscow and Riyadh, are being recycled into the best global stocks on the best first-tier global stock exchanges, including the New York Stock Exchange, the Tokyo and Hong Kong stock exchanges, and the Frankfurt, Euronext and London exchanges.

But that may be coming to a head as trillions of dollars are chasing a diminishing number of high-quality stocks, which over time will propel those shares to excessively high valuation levels.

So what’s an investor to do? Savvy investors will once again have to go with the (global money) flow, ferreting out markets that haven’t yet hit “mainstream” radar screens, but that still are likely to benefit from rising oil prices.

We refer to them as “frontier” markets and they include such mineral- and resource-rich places as Nigeria, Sudan, Egypt and Bangladesh among others. They’re obviously beyond the same old BRIC choices that have become so popular in recent years.

Most of these markets are so small that many investors overlook them altogether – but they’ll soon become very popular because of the tremendous upside they offer.

Even with political upheaval, hyperinflation, open warfare and catastrophic human and natural disasters, frontier markets are piling on stunning returns. Most are benefiting significantly from rising commodity prices that, in turn, produce higher corporate profits.

As a case in point, consider the Standard & Poor’s/IFCG Frontier Markets Composite Index posted a mouth watering 43.3% return last year. And individual markets did even better. Bangladesh turned in 128.3% while Cote d’Ivoire nailed down a 122.7% gain. The index’s worst performer, Estonia, plunged -14.2%.

Clearly with a range like that, so-called frontier markets aren’t for everybody especially since they’ve gotten so expensive as more money has flowed into them. Data shows that many are trading at Price/Earnings (P/E) ratios that range from a high of nearly 100 for Vietnam to a “mere” 35.9 in Slovenia.

Still, even at these valuations, we can make the case that higher commodity prices will allow these markets to grow for years to come – especially given that they are starting from such a small base.

Which makes them a logical choice for adventurous investors who want to get in before they become hot on the country club cocktail circuit.

Two Moves to Make Now

Unfortunately, the path to them is not as easy as we’d like to see and investment choices remain extremely limited for now.

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If you’re part of the über-wealthy set, you can probably get first dibs via high-net-worth asset-management plans and institutional offerings. And you will reap the greater rewards of having invested early.

If you’re part of the normal working class – like us – here are two very solid possibilities:

• The T. Rowe Price Africa & Middle East Fund (TRAMX), which carries a $2,500 minimum investment.
• The SPDR Standard & Poor’s 500 Emerging Middle East and Africa (GAF) exchange-traded fund (ETF), which tries to closely match the performance of the S&P®/Citigroup® BMI Middle East & Africa Index.

[Editor's Notes: In Money Morning's "Cashing in on Commodities" series we have written about uranium and coal, crude oil and timber. Next up: Look for our story on high-end commodities on Tuesday and gold on Friday. While oil and other commodities have dominated the headlines, they're far from the only investment opportunities available. And some of the other profit plays are more lucrative, and less risky. If the economic uncertainty - or the volatile markets - of recent months have you at a loss over the best moves to make next, check out Money Morning's first book, "The Essential Investor's Playbook for the Next 12 Months." At 118 pages, our just-published global-investing guide provides an insider's look at the Top 16 global trends you're likely to face over the next year or more, and contains a special chart that details more than 50 profit opportunities. And it really is a playbook: No matter what the market throws at you, you'll find a play you can call to maximize profits.]

News and Related Story Notes:

• The Independent:
  Emerging markets ‘to keep oil prices high’

• Money Morning Commodities Investing Series:
  Cashing in on Commodities: The Short- and Long-Term Solutions to the Growing Global Energy Crisis.

• Money Morning Commodities Investing Series:
  Cashing in on Commodities: What’s Driving the Oil Bull, How Much Further It Will Go, and How Investors Can Profit.  

• Money Morning Commodities Investing Series:
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• Money Morning Financial Analysis:
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• Money Morning Financial Commentary:
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• Money Morning:
  Money Morning Boosts Oil Target Price to $225 a Barrel, Thanks to Continued Scarcity, Burgeoning Demand in China.

By Mike Caggeso
Associate Editor

A six-day stock rally in emerging markets has wiped away the 2008 year-to-date loss of the MSCI Emerging Markets Index.

Rising commodity prices – particularly oil and metals – helped the index recover its 16% loss leading into the beginning of last week. 

As the U.S. economy continues to send mix signals, oil closed last week at a record high of $127.43 a barrel and gold futures rallied to $899.90 an ounce Friday, the highest level in nearly a month.

The  MSCI Emerging Markets Index  closed yesterday (Monday) at 1240.31. Some of its top 50 holdings include Lukoil (OTC: LUKOY), Petroleo Brasileiro SA (PBR), PetroChina Company Ltd. (PTR), Vale (RIO) and Cemex SAB de CV (CX).

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“As long as we’re seeing strong commodity prices, the implication is that the emerging markets are still growing,” Walter Hellwig, who helps oversee $30 billion at Morgan Asset Management, told Bloomberg. “The supply constraints in commodities are here for at least several more years, so these stocks should continue to do well.”

Also lending a hand was the U.S. Federal Reserve’s bailout of financials such as The Bear Stearns Cos. Inc. (BSC) and the Bank of England’s $100 billion rescue plan, which have boosted investor sentiment around the world.

“Two months ago, you had the capital markets fearing the world was coming to an end,” Michael Strauss, chief economist and market strategist at Commonfund, which oversees about $43 billion, told Bloomberg. “By April, you could clearly argue that the Fed not only gets it, but they’re doing creative things to address it. We’re not getting that type of nasty recession that the markets were priced to.”

Still, some emerging-market skeptics remain, including, famed investor and Berkshire Hathaway Inc. (BRK.A, BRK.B) Chairman Warren Buffett. Yesterday (Monday), Buffett flew to Frankfurt, Germany to look for acquisition targets in Europe, which is – in his opinion –a safer market to buy.

“You want to fish in a pond where there’s fish. Europe is a much better pond,” Buffett told India’s Economic Times about his decision to visit Europe instead of emerging-market countries.

News and Related Story Links:

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• Reuters:
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• Money Morning:
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• Economic Times:
  Warren Buffett scouts acquisitions for Berkshire Hathaway

The price of corn has already climbed 25% since January and established 13 new record highs. And food prices across the board are climbing to historic highs as a result.

But don’t expect a reprieve anytime soon, as farmers across the country are seeking profit elsewhere, and government emphasis on ethanol fuel is draining current stocks, creating a supply crunch.

The price of corn has surged 35% in the past year. And Terry Franci, a senior economist for the American Farm Bureau Federation, said last week that corn prices will continue to rise. In fact, Franci thinks that after averaging between $2 and $3 a bushel for decades, prices could climb as high as $6 a bushel – a threefold increase from 2005.

And while that may be a good thing for the American farmer, it’s not such a good thing for the American consumer.
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That’s because corn is an integral component in the American diet. Aside from its obvious uses as a vegetable, corn is also used to make soft drinks, bubble gum, ketchup, mayonnaise, peanut butter, bread, cereal and beer. Prices for those food items are already rising due to inflation and corn’s swelling price is causing more pain at the cash register.

In fact, food prices increased nearly 5% in 2007, the biggest annual jump since 1990. In 2007, the cost of a gallon of milk increased 26%; eggs went up 40%; and a loaf of white bread went from $1.05 to $1.28 from 2006 to 2008.

And even though the U.S. Department of Agriculture (USDA) just reported that America’s corn stocks are evaporating, don’t expect any reprieve from the National Corn Growers Association (NCGA).

Last week, the USDA put March 1 corn stocks at 6.859 billion bushels, below the average trade estimate of 7.078 billion. But despite the shortfall, the USDA also said that farmers will plant only 86 million acres of corn this year, an 8% drop from 2007.

That’s because many farmers are finding bigger profits in wheat and soybeans.

After jumping on the corn bandwagon last year, Virginia farmers and others around the country realized they were not making as much money with corn as they could by planting and harvesting wheat, and directly afterward a crop of soybeans, Jonah Bowles, the risk-management coordinator for the Virginia Farm Bureau Federation, told the Richmond Times.

Soybean acreage in the U.S. is expected to jump by 17.5% to 74.8 million acres, up from 63.6 million acres in 2007.

In Iowa, farmers are expected to plant 13.2 million acres of corn this spring, down 7% (or 1 million acres) from last year. Iowa is expected to plant 9.8 million acres of soybeans, up 14.6% from 8.6 million acres planted in 2007.

In Missouri, farmers are expected to plant 3.1 million acres of corn this year, down from 3.45 million a year ago. But they will plant 5.2 million acres of soybeans, up from 4.6 million a year ago.

There are many reasons for corn’s price spike. Growing populations, a weak dollar, and high energy costs are all forces at work. But only one cause for higher prices is actually furnished by the U.S. government: The production of ethanol fuel.

Ethanol Fuels Corn’s Price Jump

American farmers account for about 42% of the world’s corn production, and the fact that corn comes from the Midwest rather than the Mideast makes it a very popular alternative energy candidate.

So popular in fact that mandates for renewable fuels, chiefly ethanol derived from corn, have steamrolled through Washington.

The 2005 energy bill contained the first-ever requirement – known as the Renewable Fuel Standard (RFS) – that alternative fuels be mixed into the nation’s gasoline supply.

The original bill required the United States to incorporate 7 billion gallons of renewable fuels into its supply by 2012. Last year, the act was amended to require fuel producers to use at least 36 billion gallons of biofuel by 2022. In order to bring about this five-fold increase, the act also increased funding for bioenergy research and technology.

As a result of legislation such as this, the number of ethanol plants in the United States has increased 134, up from 50 in 1999, according to the Renewable Fuels Association.  Ethanol is expected to soon absorb 30% of the nation’s domestic corn production.

While the mandate was intended to decrease our nation’s dependency on foreign sources and protect the environment, the ethanol movement has had some negative consequences.

A recent study from Purdue University puts the added food cost from the renewable mandate at $15 billion in 2007 – about $130 per household. And that was from ethanol usage at a fraction of what will be required in the years ahead.

Higher prices also affect meat producers and dairy farmers who rely heavily on corn to feed livestock.  Pilgrim’s Pride Corp. (PPC), the nation’s largest chicken producer, announced in March that it was closing a North Carolina chicken processing plant, and six of 13 U.S. distribution centers, due to the jump in feed costs.

The American Meat Institute (AMI) has joined dairy, egg and turkey lobbyists to fight any increase in ethanol mandates that could divert yet more feed into fuel refineries.  In fact, AMI spokeswoman Janet Riley said the group is "absolutely" opposed to more ethanol mandates and will continue to lobby against them.

Regardless of the stands being taken against ethanol, the alternative fuel still carries heavy support in Washington where gaining independence from foreign oil and supporting of the American agricultural industry are big talking points.

Morgan Stanley (MS), the second-biggest U.S. securities firm, has already raised its price forecasts for corn and soybeans by 20% on higher demand for food and ethanol. 

"Aggressive and politically driven fuel-ethanol targets, and the need to increase acreage outside the U.S. to satisfy growing developing-world demand, will likely lend continued long-term support" to agricultural prices, said Morgan Stanley research analyst Hussein Allidina.

On average, food prices increase about 2.5% each year. This year, according to federal data, the overall cost of food is predicted to jump 3% to 4%. But as long as prices for soybeans, wheat and especially corn continue to rise, steeper increases will likely follow.

"There’s a way out of this with fewer acres, and that’s just have a bumper crop," Ed Usset, a grain marketing specialist at the University of Minnesota told the Star Tibune. "That’s a hell of a thing to just bet on."

News and Related Story Links:

• Kansas City Star:
  Corn forecast suggests rise in food prices is ahead

• London Free Press:
  Corn prices continue surge

• Energy Tribune:
  It’s About Time, Time

• The Heritage Foundation:
  Time for Second Thoughts on the Ethanol Mandate

• Brownfield:
  USDA: corn acreage down 8%, soybeans up 18%

• Bloomberg:
  Morgan Stanley Raises Corn, Soybean Forecasts by 20% on Demand

• Star Tribune:
  Food costs likely to rise as farmers change plans

• Money Morning:
  Two Ways to Profit in Spite of the Ethanol Snafu

Commodities, which have been some of the most profitable investments of the past 18 months, tumbled yesterday (Thursday). Oil and gold were just a few of the raw materials whose prices plummeted on speculation that demand will slacken and the dollar will rebound in coming months.

Crude oil fell below $100 a barrel for the first time in two weeks yesterday, extending heavy losses sustained in the previous session. Oil hit a record high $111.80 a barrel Monday, but dropped nearly $5 on Wednesday.

A report from the energy department, which indicated demand for oil may be waning amid a global economic downturn, was at least partly responsible for the decline. The Energy Information Administration’s weekly inventory report said Wednesday that overall consumption of oil and its products fell 3.2% over the last four weeks compared with the same period last year.

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Also, many speculative investors seem to be liquidating their assests and taking profits, as fundamentals do not support record high commodities prices.

"Commodity players seem to be coming round to the notion that the deterioration in the U.S. macro picture cannot be ignored on the pretext that commodities are a ‘weak dollar play’ or an ‘inflation hedge,’ and thus immune from downward pressure," MF Global Ltd. (MF) analyst Edward Meir, said in a research note.

The sudden epiphany that many commodities are overvalued also sent gold into a tailspin. After hitting a record high of  $1,034 an ounce just four days ago, gold plummeted 12% in its biggest weekly decline in 25 years.

As is the case with oil and other commodities, investors seem to be waking up from the misconception that the price of gold will rise every time the economy, or the dollar, weakens.

Dollar Bounces Back

A resurgent greenback also weighed heavily on commodities prices. The dollar staged an impressive rally Thursday, though most analysts believe it only to be temporary. After hitting a series of record lows against the euro the dollar advanced to $1.5411 per euro.

"It looked like the sky would fall, which is why we got up to those record levels Monday," Jon Nadler, senior analyst at Kitco Bullion Dealers in Montreal, told CNN. "But when the dollar started a bit of a gain [yesterday], people pulled the trigger across the commodity board."

While the dollar came off its historic lows yesterday, few analysts believe the latest upward trend is the beginning of serious recovery. More likely is the possibility that currency traders priced in a larger cut from the U.S. Federal Reserve. The Fed slashed the benchmark Federal Funds rate by 0.75% Tuesday, but many analysts had anticipated a full-point reduction.

"The smaller-than-expected Fed Funds rate cut and the emphasis on inflation risk in the Federal Open Market Committee statement have effected a reassessment of the further outlook for U.S. monetary policy," said analysts Dresdner Kleinwort, the corporate and investment banking unit of Germany’s Dresdner Bank AG. "As the market regards the potential for another rate cut as small, gold and other metals are under pressure."

Many analysts believe after a mild recovery, the dollar will continue its downward descent, perhaps falling as low as $1.60 per euro.

"I would see this as a temporary [move] since we expect that the Fed will go on cutting. I don’t think we’ve seen the lows for the dollar and I don’t think we’ve seen the low for stock markets. It’s unlikely that this will be the bottoming out for risk aversion," Johan Javeus, FX strategist at SEB in Stockholm, told Reuters

News and Related Story Links:

• MarketWatch:
  Gold continues slide as dollar rallies

• Wall Street Journal:
  Dollar Continues to Strengthen As Commodity Prices Tumble

• BusinessWeek:
  Oil falls under $100 on waning demand

• Bloomberg:
  Gold Leads Commodities Plunge on Outlook for Dollar, Economy

• Money Morning:
  Dollar in Dumps, Sends Commodities Soaring Higher

The prices for oil, gold, and platinum all hit record highs last week, as investors strengthened hedge positions against weaker equity markets and inflation.

"People want to get into commodities and damn the consequences. Given what is going on in other markets – equities are wobbly and some bonds are verging on toxic – people see commodities as a safe haven," MF Global Ltd. (MF) analyst Edward Meir told Reuters.

Oil prices closed at a record $100.74 a barrel on Feb. 20 amid signs that the Organization of Petroleum Exporting Countries (OPEC) would cut supplies. Though, they did experience a brief respite Thursday after the Energy Information Administration announced U.S. crude supplies were at their highest level since November.

Supplies climbed 4.2 million barrels, nearly twice as much as forecast, to 305.3 million barrels for the week ended Feb. 15.

Regardless of underlying fundamentals, more investment in oil seems likely as inflation spreads and equity investments lose value. Consumer prices rose 0.4% in January, the Department of Labor reported last week. Import prices also increased in January, rising 1.7%. The dollar has dropped about 8% since the beginning of 2007 when compared to a basket of trade-weighted currencies from major U.S. trading partners.

As a result, oil has averaged $93.02 a barrel this year, up nearly a third on 2007’s average of $72.30. Contrarily, the Dow Jones Industrial Average is down slightly more than 4.1% since February 23, 2007 and the Standard & Poor’s 500 Index is down about 8.7% in that time.

"Fundamentals have indeed loosened since the first time [West Texas Intermediate] hit 100 USD on January 2, 2008, and do not appear to justify this week’s record price levels" a report from Bank of America read. "Strength in prices across commodities indicates that the rally is likely fuelled by fresh inflow of capital as investors see commodities as an alternative asset class."

Those investors also helped gold and platinum soar to their own record highs last week. Gold rallied to $953.60 an ounce last Thursday, and platinum for immediate delivery advanced $37.50, to a record $2,206 an ounce. Platinum has gained 29% since Jan. 25.

"Crude oil is hitting $100 a barrel, corn, soybeans, and wheat are hitting a record high everyday, so precious metals are getting attention," Yuichi Ikemizu, head of commodity trading at Standard Bank PLC, told Bloomberg News.

Prices for gold and platinum have also gotten a boost from power shortages and flooding in South Africa, which forced mining companies to curtail energy usage by at least 10%.

"The platinum price has been driven to record levels by flooding and power shortages in [South Africa]. This has seen strong investor buying," Tom Kendall, precious metals strategist at Mitsubishi Corp. told Business Day.

Anglo Platinum (OTC:AGPPY) recently said output at its Amandelbult mine was diminished by flooding, and it may be three months before it comes back on line. The mine could lose 50,000 to 70,000 ounces of production, an amount comparable to four days worth of world supply.

South Africa provides four-fifths of the world’s platinum, and is second only to China in gold production. Given the current economic climate – and supply crunch – it seems like these commodities and others may have further to go.

Commodities are in their seventh year of gains as underinvestment in refineries, mines and land sent prices for oil, gold, platinum and wheat to record highs. About $175 billion is invested in commodities, according to Barclays Capital (BCS).

"There is a true shortage of capacity, the world is growing quickly and the only way to resolve the shortage is to have a very liquid market of commodities with a high level of participation," Francisco Blanch, head of global commodity research at Merrill Lynch & Co. Inc. (MER) told Bloomberg.

News and Related Story Links:

• Bloomberg:
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• Reuters:
  COMMODITIES-Near records, still a safe haven in choppy seas

• Bloomberg:
  Long commodities runup seen

• Money Morning:
  Platinum Hits Another Record High as South Africa Shorts Supply

Almost two months into a new and volatile year, investors have already been trying to figure out what will be the big winners when November and December come around.

But instead of looking ahead, in this instance, hindsight may prove more fruitful.

The agriculture markets have been on fire for the last couple of years. Corn and soybeans have skyrocketed on the back of huge ethanol demand. Wheat exploded as droughts cramped supplies and demand in emerging markets soared.

Seeing dollar signs, many farmers have decided to use their land to grow more profitible crops. For the short-term, that may pay off the mortgage but the longer-term effect could spell shortages [thus producing price increases] for those soft commodities they’ve stopped growing – in this case, cotton.

According to the National Cotton Council’s early season planting intentions survey in 2007, U.S. growers intended to plant 13.2 million acres of cotton in 2007. This was a significant decrease of almost 14% from 2006, and the 2008 decrease is expected to be even more dramatic.

But at the same time, demand for the softest of soft commodities hasn’t waned – if anything, the rapidly growing middle classes of China, India and Latin America are buying more T-shirts, jeans, hats, etc. 

In fact, China is wasting no time securing the natural resources it needs to keep its economy going – and that includes cotton. China is also smartly buying now, while cotton is cheap.

The emerging powerhouse is so serious about cotton that it has created its own cotton futures market. Many analysts had noted an imbalance between China’s growing economy and the relatively small size of its domestic futures markets. This imbalance was seen as a negative and something that could hinder China’s development in the long run.

The ‘Gigantic’ Zhenghzhou Cotton Futures Market

Chinese merchants and manufacturers are very serious about the cotton business; all you have to do is look at cotton futures trading on the Zhengzhou Commodity Exchange (ZCE).

The exchange is the center of cotton trading in Asia. Daily volume in Zhengzhou cotton futures – which will complete their first year of trading on June 1 – is now running at about 50,000 contracts. Open interest at the ZCE has been running between 60,000 to 80,000 contracts per day since last November.

To put it in perspective, the New York Cotton Exchange reached the 70,000 contracts per day threshold only after a century of trading. Literally, it took 120 years and a record U.S. cotton crop to accomplish it. The ZCE did it in less than a year.

Even with all the global interest in cotton, the futures have sold off heavily and there is a lot of bearish sentiment – at least until now.

Why Cotton is Looking Oversold

If the picture is so bullish for cotton, then why has it been selling off so much lately?

One big reason is demand has not been as high as expected in the first quarter, which has limited the upside trade in cotton, at least for now.

Cotton futures have had a bit of a boost in the last few months that will likely continue during 2008 because of speculative fund buying in cotton. The price for cotton is still relatively very cheap.

Analysis of the farming regions in the U.S. indicates that all areas will have some reduction of cotton, mostly in the south.

Also, weather is always a major factor for any agricultural commodity, and it will be pivotal in determining final crop size, no matter what.

Clothing, home furnishings, and even medical supplies are all industries that rely heavily on cotton. If the weather influences the harvest the way many are predicting, the price of cotton could be the next great bull market in commodities.

 Locked Out of Cotton

Unfortunately, most U.S. investors can’t directly tap a cotton-specific ETF – officially called ETFS Cotton and only traded on the London Stock Exchange.

Until something local arrives, investors will have to follow the farmers’ pursuit of other hot agricultural commodities.

Deutsche Bank’s Power Shares Agricultural Fund (DBA) is intended to reflect the performance of commodities in the agricultural sector – soybeans (31%), wheat (28%), corn (23%), and sugar (16%).

Van Eck’s recently launched Market Vectors Agribusiness ETF (MOO) takes a different approach. This fund reflects the infrastructure of the agriculture industry, focusing on chemicals (34%), agri-product operations (33%), equipment (24%), livestock operations (6%), and ethanol/biodiesel (2%).

Those investments aren’t shots in the dark, either. In fact, you might take comfort knowing that famed investment guru Jim Rogers – who predicted the global commodities boom we’re experiencing more than a decade ago – has said several times recently that he is buying agricultural commodities. [To see how you can obtain a free copy of Rogers' just-released bestseller, "A Bull in China: Investing Profitably in the World's Greatest Market," please click here.]

News and Related Story Links:

• Money Morning:
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• Money Morning:
  Outlook 2008: Five Ways to Profit From Soaring Agricultural Prices

When Dean Foods Co. (DF), the biggest U.S. dairy producer, reported this week that its fourth-quarter profits were slashed by 55%, the culprit was a 47% jump in the price of milk, a key dairy commodity.

Conversely, soaring demand for natural-resource commodities including coal has generated tremendous business opportunities for DryShips Inc. (DRYS), a company that owns and operates dry bulk carriers around the world.

Commodity prices of all types have been on the march over the past several years. From a business standpoint, those price increases clearly cut both ways, helping some companies and hurting others.

For investors, the challenge is figuring out which commodities are continuing their surge and which ones are enduring a price reversal. For every commodity on earth – from milk to gold – there are specific catalysts that influence supply and demand. And that’s the best way to explain why some commodities have fallen from highs in 2007, while some continue to soar into 2008.

Sometimes it’s tough to tell just who’s winning and who’s losing: While gold mining companies are rejoicing over gold’s leap past $900 an ounce, high prices are to blame for overall demand dipping 17% in the fourth quarter. 

Soft Commodities: Buying the Farm

When it comes to so-called "soft commodities," the powerful pricing trends that arose last year have carried through into this year, with a number of soft commodities posting record highs:

• Wheat futures hit a record of $11.53 a bushel on Feb. 11, but have since fallen below $9.80. However, analysts are saying this is just a pullback, as wheat’s price doubled last year.

• Soybean futures hit a record of $13.745 a bushel on Feb. 8. Overall, they gained 72% last year.

• The average January 2008 price for cotton (74.33 cents a pound) was the crop’s highest in 46 months.

• Corn futures are at $5.07 a bushel as of yesterday (Thursday), their highest levels since 1996. 

"We’re in something like a gold boom, a wool boom," Brett Stevenson, a forecaster for AgRisk, told Australia’s ABC News. "We’re in extraordinary territory."

The emergence of China and India – and the increasing use of biofuels – has driven up demand across the board for commodities. At the same time, droughts, floods, and the conversion of farmland into residential property because of soaring land values, have all combined to crimp the supply of the commodities from farmers.

Historically, supply and demand has fluctuated wildly at times. But there’s been one constant: People always had to eat.

If nothing else, that one fact will help make soft commodities a relatively safe long-term bet.

Black and Gold

Metals also posted record highs last year. While some have skidded from those highs in the New Year, others have continued their ascent:

• On Jan. 28, gold hit a closing high of $927.10 an ounce – and that’s after it gained more than 25% last year – but has since slipped down to $909 an ounce.

• Platinum hit a record high for its eleventh day in a row yesterday, reaching as high as $2,025 an ounce. After its 37% gain last year, the metal has already jumped 33% this year, Reuters reported.

• The price of coal is up about 37% already this year, with power-station coal prices reaching $125.48 per metric ton for the week ended Feb. 8. It marked the third straight week of record-high coal prices.

• On Feb. 12, silver peaked at its highest price [$17.60 an ounce] since the metal set its all-time high of $49.45 an ounce in 1980. And this isn’t news – the metal has made remarkable annual gains every year since 2003.

• Futures for crude oil were $94.63 a barrel as of yesterday. Oil eclipsed $100 in January but remains lower on concerns that economic growth would dampen demand.

The supply-demand equation for these commodities isn’t as simple as that of soft commodities.

Take gold, for example. It’s seeing a rush of new investors because of the falling dollar and plans to cut U.S. interest rates even further. To them, gold is the epitome of investment security.

However, soaring prices mean that jewelry costs more. And you know the price is getting too high when fourth-quarter gold sales fall 64% in India – a country that accounts for about one-third of the world’s retail demand, The Wall Street Journal reports. But even in that country, gold isn’t worth overpaying for.

Coal is different. Nobody personally wants to buy it, but all countries need it. And the chief catalyst behind the fossil fuel’s record run is demand from such emerging nations as China and India that have undergone a rapid economic and industrial expansion.

"All over the world, everyone is looking for coal because all economies are developing … so they need energy … that’s why we are in this situation," Exxaro Resources Ltd. (OTC: EXXAY) Chief Executive Officer Sipho Nkosi told the Daily Dispatch.

What is Jim Rogers Buying?

Famed commodities guru Jim Rogers – who predicted the global commodities boom we’re experiencing more than a decade ago – recently conveyed his views to Yahoo! Finance.

The bottom line: Rogers is backing away from precious metals right now, mainly because he fears the U.S. economy is headed for a recession.

"If the largest economy in the world goes into a recession, that’s going to affect people. That’s going to affect the demand of everything. So I’m not sure I would buy metals right now."

However, he’s "buying agriculture [commodities] as we speak."

"As other parts of the world grow, they like to eat more," Rogers said. "There are 3 billion people in Asia. That’s billion with a ‘B.’ In America, we have 300 million. There are 10 times as many people over there, so I see good things happening in agriculture." [To see how you can obtain a free copy of Jim Rogers' just-released bestseller, "A Bull in China: Investing Profitably in the World's Greatest Market," please click here.]

But how does one invest in agriculture? With gold, you can buy coins, or bullion. But the typical individual investor can’t buy a bushel of corn or soybeans, and then find a nice dry and safe place to store them and wait as they appreciate.

Deutsche Bank’s PowerShares Agriculture Fund (DBA) is intended to reflect the performance of four commodities in the agriculture sector – soybeans (31.13%), wheat (28.87%), corn (23.43%) and sugar (16.58%). These include some of the key commodity plays that Rogers advocates.

Another is Van Eck’s recently launched Market Vectors Agribusiness ETF (MOO). Like the PowerShares Fund, this reflects the agriculture industry, albeit in a different way. Instead, the ETF’s holdings reflect returns seen from agriculture chemicals (34%), agriproduct operations (33.5%), agriculture equipment (24.3%), livestock operations (5.6%) and ethanol/biodiesel (2.3%).

News and Related Story Links:

• New York Times:
  This Year, Commodities Are on a Rockier Road

• Bloomberg:
  Dean Foods Profit Falls 55% on Soaring Milk Costs

• MarketWatch:
  High prices dampen fourth-quarter gold demand

• ABC News (Australia):
  Demand for soft commodities drives agricultural mini-boom

• Money Morning:
  Outlook 2008: Gold Investments Will Continue to Glitter in the New Year

• Reuters:
  Platinum hits record at $2,025

• MarketWatch:
  Fed stands ready to ease further, Bernanke says

• Wall Street Journal:
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