INVESTING: Signs point to strong rally in agricultural commodities

The biggest stories of 2007 have been oil’s relentless rise and China’s growing presence on the world stage. These two are obviously related, as energy needs in China help push oil prices higher. But things move in cycles, and as the world economies slow down and U.S. stocks move into a bear market, there is another way to play these two stories that should continue to dominate our lives the next five years.

The next several years could be characterized by an economic battle for resources. We already know the effect the battle is having on energy prices. The next battleground will be agricultural commodities. The common myth is that the drive to create ethanol is causing corn prices to go up, and that is a part of the problem. But it is more far-reaching than just corn. The increasing wealth in emerging economies around the world is creating demand for better and more diverse food choices. This is having a massive and long-term effect on all kinds of food products, from wheat and soybeans to sugar and meat.

There are a few ways to make money from the higher prices ag commodities will see. You can buy a farm and grow wheat, but that sounds like work. You can move to Chicago and start trading in the fabled futures pits. Not as physically hard as running a farm, but perhaps more stressful.

I think I have a better idea. The exchangetraded funds I am always talking about have come up with another answer to an investing problem. A new fund released earlier this year contains a basket of ag commodities. The fund, which goes by the ticker DBA, is about an equal split of wheat, sugar, corn and soybeans. DBA trades like any other stock.

Investing in these commodities is not exactly the same as buying oil five years ago. It is harder to create a larger supply of oil. But it’s also not that easy to plant more corn. There is only so much land left around the world that can be dedicated to farmland, even as the global population increases and approaches 7 billion. Add environmental and political restraints, and we have a serious problem trying to increase acreage.

From 1974 until this year, wheat, corn, sugar and soybeans traded in a wide band. A few months ago, wheat finally broke out and now is sitting just off an all-time high. Ironically, even with the increased demand driven by ethanol and biodiesel, corn and soybeans are not yet out of their ranges. But I think it is only a matter of time, and a short time at that. This investment has the potential to see extreme volatility, but if you can sit through some sharp drawdowns, a home run could be waiting.

As for that little comment I slipped in earlier about the United States moving into a bear market, that wasn’t just to grab some attention. More than two months ago, I suggested reducing equity exposure to 50 percent or less in light of coming weakness. That weakness has turned into a cancer. Any year-end rally that develops should be used to increase defensive positions even more.