Grain prices are soaring to meet rising worldwide demand for food and fuel, causing the biggest jump in U.S. food prices in more than 15 years. That hurts, particularly for lower-income people. On the other hand, the surge in agricultural commodities creates potentially lucrative investment opportunities in the entities that grow, harvest, distribute and service the global food machine.

"Why get mad when you can get in on it?" comments Peter Schiff, president of Euro Pacific Capital, a Darien, Conn., broker-dealer that specializes in overseas investing and has a sizable stake in commodities. "The government says that there's little inflation if you take out energy and food, but I want to invest in those areas because that's what's going up. Why not benefit from it by owning companies in those sectors?"

The agriculture boom mirrors the overall bull market for virtually all commodities so far this decade. Perfect storm conditions of unprecedented global growth and favorable supply-and-demand conditions have made Mother Earth's bounty of energy, metals and food a gold mine for investors. But agriculture was a relative latecomer to the party.

"During the past ten years, agriculture has been flat to down and has been a laggard versus energy and metals," says Kevin Rich, chief executive officer of DB Commodity Services, the Deutsche Bank subsidiary that manages several PowerShares currency- and commodity-based exchange-traded funds, including the PowerShares DB Agriculture fund. "But there have been a lot of structural changes in the global demand for agriculture during the past couple of years."

The changes include rising living standards in emerging market nations-particularly China and India-resulting in more demand for meat and dairy products, which boosts demand for grains to feed the animals. The U.S. government's mandate for more ethanol means less corn for animal feedstuff and higher corn prices for meat producers. And the race to plant more corn means less available acreage for soybeans, which can drive up prices for that valuable crop. Elsewhere, Australia's severe drought has helped elevate wheat prices to record levels.

These are giddy days down on the farm, but commodities are notoriously cyclical beasts marked by long troughs. That said, many people believe the current uptrend still has legs. "I think the commodities game is still in the early innings," says Jeff Saut, chief investment strategist at Raymond James Financial.

Others are more effusive. "Our view is that commodities as a whole have 100% to 200% more upside," says Rob Brown, chief investment officer at Genworth Financial Asset Management. "It's one of the most likely, robust and assured investment opportunities in existence."

That's so bullish it makes one wonder if we're at the point where the bubble is about to burst. Noted investor and author Jim Rogers, in his 2004 book Hot Commodities, stated the case that commodities in general are in a sustainable bull market that could last for another decade. He said commodities had three long bullish periods in the 20th century (1906-1923, 1933-1953, 1968-1982) that lasted on average slightly more than 17 years. Rogers wrote that during the past 130 years commodities and stocks have alternated leadership in regular cycles averaging 18 years.

Rogers' theory for this phenomenon is that higher commodity prices mean higher costs and lower profits for companies, which hurts stocks; the flipside of this is that lower raw commodity costs benefit companies' bottom line. One recent example of the former situation is Dean Foods, the nation's largest dairy products company, which in October cut its 2007 earnings forecast by more than 17%, in part because it can't fully pass through higher grain costs to consumers. As of early October, its stock had plunged nearly 30% from its 52-week high.

Commodity cycles run like this: Oversupply causes big drops in prices, leading to sharp reductions in capacity and, ultimately, huge imbalances in supply and demand. When demand outstrips supply and prices rise, commodity producers scramble to rebuild capacity, a multiyear process given the long lead times for digging mines and building refineries. Eventually, oversupply swamps the market and prices drop, ushering in the next bust cycle.

Within megacycles, there can typically be plenty of mini-bubbles and mini-busts. Rogers believes the current commodity bull market began in 1999 and, if history is a guide, could run until about 2016 or so. He also expects volatility along the way.

Pork Bellies And Beyond

The vast food complex runs the gamut from fertilizer producers to water industry companies. One of agriculture's shining stars has been Potash Corporation of Saskatchewan, whose three main products-potash, nitrogen and phosphorus-are used in fertilizers and animal feed. As of early October, its gravity-defying stock had more than doubled year-to-date and had more than tripled during the past two years. It recently sported a P/E multiple of 32 times estimated 2007 earnings. Think about it: a multiple of 32 for potash, one of the unsexiest products imaginable.

There are several ways to play the agriculture game, from buying stocks in agribusinesses to purchasing futures contracts on specific crops to investing in mutual funds or exchange-traded funds based on indexes tracking either the broad commodity universe or more agriculture-specific targets.
Saut says he likes backdoor plays such as Lindsey Corp., a maker of irrigation systems, or fertilizer companies such as Terra Industries, a maker of nitrogen-based products for farms and industry. He thinks that food production will probably be centered on places with ample arable land and abundant water supplies such as Canada and Brazil. One company he likes is Saskatchewan Wheat Pool, a Toronto exchange-listed giant that's Canada's largest agribusiness. It recently changed its name to Viterra after it merged with another large Canadian grain handler, Agricore United. He also believes now is a good time to buy arable land in Brazil.

Saut prefers to invest in individual ag-related stocks and commodity-related funds. "Investing in companies is better than futures contracts because weather can quickly alter contract prices," he says. "Unless you follow them closely, it's easy to get burned."

Straight To the Source

According to Facts and Fantasies about Commodity Futures, a paper published in 2004 by the Yale International Center for Finance, investing in commodities futures far outpaces investing in commodity-related companies. The authors, Gary Gorton and K. Geert Rouwenhorst, found that the cumulative performance of futures tripled the performance of "matching" equities from 1962 to 2003.

From the perspective of asset allocation, the beauty of commodities is that they're supposed to have low correlation to both equities and bonds. Larry Swedroe, a principal and director of research at Buckingham Asset Management, writes that commodities were up an average of 30% in each of the nine years that bonds posted negative returns since 1970. In the eight years stocks were in the red during this period, commodities averaged  returns of roughly 23%.

Commodity companies can move more in line with the overall equity market than with the underlying commodities they participate in, so they often have a higher correlation with equities than with pure-play futures contracts on specific raw materials.

Eligible, qualified investors with a net worth of at least $1 million, or an income exceeding  $200,000 (or a $300,000 joint income) for two consecutive years can trade individual commodities through a broker or a registered commodity-trading advisor (CTA), who must belong to the National Futures Association and must register with the Commodity Futures Trading Commission.

Many individuals invest in commodities through mutual funds or exchange-traded funds that track any of a half-dozen commodity futures indexes. Index compositions can vary significantly depending on the weighting assigned to various commodity sectors. For example, the Goldman Sachs Commodity Index's 70% weighting toward energy far exceeds the other indexes. Similarly, its 10% agriculture weighting is the lowest among the major indexes-the others weight it anywhere from 18% to 23%.

Peter Schiff from Euro Pacific Capital invests in regions benefiting from the agriculture boom such as Canada, Australia and New Zealand. That can range from processors and growers to utilities and financial companies that provide the infrastructure to support the farm economy. He also buys closed-end ETFs listed on the London exchange  that track various individual ag commodity futures such as corn, coffee and wheat.

Nothing But Ag

Two ETFs that debuted this year offer pure-play exposure to agriculture. The PowerShares DB Agriculture fund is based on the Deutsche Bank Liquid Commodity Index, which constitutes futures contracts on corn, wheat, soybeans and sugar. As of October 5, the fund had returned more than 13% since its inception on January 5.

The fund seeks to mitigate contango, a potentially significant yet little-publicized problem for commodity futures that exists when a far-future delivery price costs more than a nearer-future delivery price. Rolling expiring contracts into more expensive future contracts costs investors money. Rather than follow a fixed-rule basis rolling period such as one month or six months, the PowerShares DB Agriculture observes the next 13 months worth of contracts and calculates the implied roll yield on all 13 to choose the most optimal period.

The opposite of a contango market is called backwardation, when further-out contracts cost less than near-term contracts. Futures markets can be in contango or backwardation depending on a commodity's underlying fundamentals, supply and demand or other factors. Commodity markets on the whole are currently in backwardation.

In September, Van Eck Global launched the Market Vectors-Agribusiness ETF that tracks the DAXglobal Agribusiness Index, a basket of 40 agribusinesses that includes food processors; livestock operations; equipment and transportation companies; and ethanol/biodiesel producers. The index's major companies include Monsanto, Deere & Co., Archer Daniels Midland and Potash Corp. of Saskatchewan. The fund, which trades under the aptly named ticker symbol MOO, gained more than 11% since its inception on September 5. But the collective P/E ratio among index companies was a hefty 27.53.

Formerly plodding agriculture is now running in the fast lane, but the run-up in index performances and in the valuations of certain agribusinesses might give investors pause despite the sector's seemingly positive long-term trends. "One thing that concerns me is the state of risk denial in commodities," says Rob Brown of Genworth Financial. "At some point there will be a risk repricing. That might be the perfect time to enter, back up the dump truck and load up."