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By: Costas Bocelli — January 26, 2011

The "Ag's" Are Hot. Here are 7 Ways to Profit ...

Editor's Note:  Once again, please be sure to check out this week's contribution from Guest Contributor Tom Putney, who will be writing a series of articles for you on currency investing.  Tom brings more than 20 years of trading experience, including 6 trading the Forex market, where he traded $250 million in volume per month as a Certified Trading Advisor.  You'll find his article immediately following Costas' contribution for the week.
 
 
While the United States is fending off core deflationary pressures that pose a major threat to our fragile economic recovery, inflationary aftershocks are being felt around the world as a result.

Ultra loose monetary policy, driven by the Federal Reserve's $600 billion quantitative easing program, is not only driving headline consumer inflation higher domestically, but emerging markets are feeling the effects at a staggering pace.

As foreign central banks combat inflationary pressures through interest rate hikes and currency stability techniques, there has been a general pull back in the commodity space.

Most notably, precious metals such as gold and silver have pulled back considerably since the start of trading in 2011.  Base industrial metals like copper and aluminum have weakened from their peaks as well.  Even crude oil has slipped below $90 a barrel, and may test short to intermediate term support levels.

However, bucking the trend are the agricultural commodities.

Is The Ag Space Going to Be The Leader in 2011?

They're off to a strong start, with Corn, Wheat, and Soybeans leading the way.  While food prices are expected to rise a modest 2-3% here in the United States, it's a whole different story in emerging and poor countries.

China and India are seeing food prices rise in the double digits.  Poorer nations are seeing prices and anxiety rise to levels that are approaching the food crisis in 2008.  The majority of these populations spend a significant amount of their incomes directly on food, in some cases half of their earnings.  When food prices rise drastically or supply becomes constrained, civil unrest is a direct threat.

Here is a daily chart on the March 2011 Wheat futures contract ...
 

(Click on image to enlarge)

 
 
The charts of Corn and Soybeans are very similar.
 
Aside from the reflationary pressures that the Federal Reserve is applying to the general commodity space, the Ag space has been immune to the inflation-fighting tools that have stopped other commodity prices in their tracks, like the metals and oil.

The strength lies solely in the inherent need for food, as global population demand is outstripping supply production.

The United States Department of Agriculture, in its latest annual crop production and grain stock report, has indicated that 2011 will see below average production per acre.  Weather and farmland conditions are the primary drivers.

These estimates, coupled with inclement weather in other major producing areas around the world, has put global supplies behind schedule.

The droughts in Russia ravaged the wheat crops last year to the point where the country was forced to ban exports to ensure adequate domestic supply.

Other countries, like India and China, also saw bad weather drive production yields below estimates, putting further pressure on supply.  These countries have populations of over 1 billion citizens, and are importing as much as they can.

As emerging markets like Brazil and Asia strengthen, the demand for food grows immensely, particularly for more expensive food groups like meat.  Demand growth for cattle is putting further pressure on the grains which are the primary diets for livestock.

Even though oil has pulled back recently, it's still well north of $80 a barrel.  Many analysts are expecting crude oil to trade above $100 in 2011.  Higher oil prices prompt investment and greater attention towards alternative energy sources like Ethanol.  This bio fuel is most popularly derived from Corn, which creates direct competition with the food market for supply.

How to Get Exposure to the Grains

There are several ways to profit in the Ag space.

The most transparent play would be direct exposure to the grain prices.  The iPath grain ETN (symbol: JJG) gives you exposure to all three -- corn, wheat, and soybeans.  This ETN trades about 200,000 shares a day on average, but does not trade options.

If you prefer a more liquid play, consider the PowerShares Agricultural ETF (symbol: DBA).  This asset has a more eclectic mix of the soft commodities.  It's much more liquid than JJG, trading over 2 million shares a day, and the options are very liquid.
 

(Click on image to enlarge)
 
For the more seasoned investor, consider some second derivative plays in the Ag sector.

A favorite group is the farm and equipment companies that manufacture products in high demand from agricultural producers.  Look at companies like Caterpillar Inc. (symbol: CAT) and Deere & Co. (symbol: DE).  Any pull backs should be good opportunities to get bullish exposure.

Another second derivative play is in the fertilizer space.  As new farming acreage is difficult to cultivate, producers look for ways to maximize yield on existing farmable land, especially when they're getting top dollar on the open market.  Fertilizer additives are in high demand as phosphates, potash, and hybrid seed technology can boost production, which leads to higher profits.

Companies like Mosaic Co. (symbol: MOS), Potash Corp. (symbol: POT), and Monsanto Co. (Symbol: MON) are well positioned when grain prices are rising.

The fundamental story is well in place for the Ag's in 2011.

Bon Appétit!

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