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Forget Stocks, Bonds--It's The Year of Commodities

With stocks struggling to overcome a slumping economy and bonds providing a safe but low-yield alternative, 2008 could well be the Year of the Commodity.

Prices are surging across the board in the futures markets, with everything from corn to cocoa to crude oil at or near record levels.

AP

Indeed, investors looking to cash in on hot-trading commodities can make a lot of money in a hurry -- or they can get badly burned, as happens to people entering the complicated trades without the sufficient background knowledge or capital to do so.

Learn How to Trade Commodities, Click Here.

The trick to making money in commodities, according to experts, is to learn exactly how the trading works, hook up with someone who knows what they're doing, and have enough cash to cover the often-wild swings in the markets.

"People need to make sure they know what kind of risk they have, to figure out what type of investor they want to be," says Christian Mayer, a market adviser at Northstar Commodity in Minneapolis. "In these types of markets it's much easier to be a shorter term investor than longer term because these markets are jumping around so much that it requires a lot of margin."

Take wheat, for instance, a grain that has been continuously hitting new highs on the exchanges.

In volatile trading Thursday, wheat for March delivery closed at $10.32 a bushel, up 90 cents. Because the trading surged so much the Minneapolis exchange lifted the trading limits, or the degree to which the price could swing profit or loss, to $1.35 for Friday trading.

That means a tremendous opportunity to both make and lose money -- $6,750 each way on a single 5,000-bushel contract. Traders asleep at the wheel can face huge losses from margin calls, making it different from equities trading where investors can buy common-share stocks and sit on them for an indefinite period of time and only lose the amount of money they invested.

"You definitely have to be watching pretty closely," Mayer advises. "It's not the kind of market where you can put in a trade and walk away and look at it two, three weeks later, because this market is going to be up quite a bit."

Corn Blows Past Record

The big story in agricultural commodities over the past year is corn, which has been in heavy demand since President Bush signed a renewable fuels standards law last year that mandates the country change much of its gasoline consumption to ethanol. The demand saw farmers last year switch millions of acres once used to plant soybeans and other products to corn.

In the meantime, corn's price swelled, going from around $2 a bushel in the early part of 2007 to more than $4 after the fuels bill was signed, and now to $5 as the price for all fuel including ethanol has jumped over the past several months.

Soybean field
AP
Soybean field

And other agricultural commodities have gained sharply as well. In addition to wheat, soybean and cotton futures also have hit near-record levels, and that will impact the market this year significantly.

As such, many of those corn acres will switch back to soybeans this year. Some experts think corn could surrender as much as 3 million acres this year as global demand continues to pump up soybean and wheat prices. The net effect is likely to be bullish for corn when the Department of Agriculture releases its key crop plantings report on March 31 that provides a broad outline for the year's agricultural industry.

"The underlying story for corn and for every agricultural commodity is this battle for acreage, and that has been going on ever since harvest got over," said Elaine Kub, a commodity market analyst at DTN agricultural consultants in Omaha, Neb. "Speculators are coming in and there was a large inflow of money, particularly in January. That's just sparked this incredible rally."

To careful investors, that means opportunity.

"On corn, you're in a very interesting market right now. You have these higher (price) levels but the demand isn't falling off," says Mayer, who believes corn is headed for $6 a bushel. "Longer-term corn is a good trade to have."

The Corn Domino Effect

Corn has a tremendous domino effect on the economy.

Corporate bottom lines are impacted somewhat by higher corn prices, as many major food producers use corn and its byproducts, particularly high fructose corn syrup, to produce everything from snack foods to soft drinks. Livestock farmers who feed corn to their cattle, hogs and chickens are impacted, and prices of those goods are expected to rise even more over the next year.

Also, ethanol plants get hit by having to pay more for the principal product that makes their operations run.

All of which puts numerous areas of the economy in a precarious position should there not be a bumper crop of corn this year as acreage is reduced. That also would drive corn prices significantly higher.

"If we have a shock in corn yields that reduces them by 10 percent or something, that's going to create a tremendous amount of havoc, not only for ethanol but also for other demanders of grain," said Bruce Babcock, director of Iowa State University's Center for Agricultural and Rural Development. "That's the real problem. We are going into this year now without a stock inventory that will handle a drastic problem with yields."

In the meantime, cattle prices likely will be driven higher as farmers bring fewer and smaller animals to the market because of the higher feed costs. Consumers also will be hit in the form of higher prices at the meat counter.

"You can't raise prices by this amount and expect everyone to pretend it didn't happen," said Daryl Ray, director at the University of Tennessee's Agricultural Policy Analysis Center. "Margins in livestock feeding are fairly tight, so you're going to have to see the market price eventually cover that increased cost in feed."

Other non-agricultural commodities are booming as well. Coal traders are taking advantage of global supply issues, while London coffee, cocoa and sugar futures all hit multiyear highs Friday as more and more money is shifted out of stocks.

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