From Dominic Frisby, in London

Dear Money Morning reader,

The fundamental case for investing in grains is compelling.

There's the world's ever-growing population, all of whom need to eat. In particular, there are the expanding middle class populations of Asia, all expecting better diets. It takes a lot of grain to rear a cow, chicken or pig.

There is the threat of increasingly volatile weather, bringing drought or flood to disrupt crop growth. There's the apparent shortage of new, good-quality arable land. Then there's the fact that much of US corn production is used to make ethanol.

But these are hardly new sales pitches. Let's take a look at the case for the grains today. Is now the time to buy?

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After years of stability, grains shot up in price

Let's start by looking at a chart of wheat for the last 25 years.

You can see that wheat spent the vast part of the '80s, '90s and '00s trading in the $2.50 – $4.50 per bushel range. That is, apart from a large spike in 1996, known as 'the 1996 grain price shock', that was the result of a drought in the Midwest.

Corn followed a similar pattern, trading between $1.80 and $3.20, again with a 1996 spike. Soybeans seem to be slightly more volatile. They followed the same direction, but had bigger rallies in 1989 and 2003.

But then, in the atmosphere of all-out speculation that gripped the world in 2006 and 2007, the grains began their greatest run in history, with wheat and corn leading the way. Wheat went from $3.00 to north of $10.00, while corn rose from $2.00 to $7.20. Soybeans almost tripled as well, going from $5.50 to $16.00 per bushel.

Fortunes were made. American farmers had never had it so good.

Other commodities are following a similar pattern

We've seen a similar story throughout the commodities complex. Oil for example, is still about 50% off its all-time high of $147 a barrel. But trading now in the mid-$70 range, it's still many times higher than where it began the decade.

Copper began the decade at around $70 per pound. After soaring north of $420, in the 2008 bust it properly capitulated. But it still only fell back to $140, double where it began the decade. It now sits back around the $300 mark.

This is partly a symptom of the ever-declining purchasing power of modern money – the great inflation that goes undetected by the retail price index, consumer price index, or any other government-sponsored measure.

But it's also a symptom of great bull markets. For example, there was the bull market in stocks that went from 1982 to 2000. Many people lost their shirts in the crash of 1987, but many managed to hang on and ride the bull – particularly those who got in early. Markets took time to recover after the crash of 1987, but there were still another 13 years of bull market to go.

For commodities as a whole, 2008 may prove to be what 1987 was to stocks – a short, severe correction in a longer-term bull market. Commodities, for the most part, are up on the decade, but stocks are not. They are still mired in a bear market that began in 2000 and is probably many years from being over.

Many people lost their shirts in commodities in 2008. But anyone who got in during the early part of the decade and managed to ride the bull will be fine now and looking to further gains in the future. These gains are based on all those fundamentals we know so well by now – put simply, falling global reserves meeting increasing global demand.

Trading in soft commodities is not for the faint-hearted

But as my colleague John Stepek pointed out last week, trading soft commodities directly is not for the faint-hearted. I would be a buyer of wheat around the $4.50 mark, of corn around the $3.40 mark, and soybeans around the $9.50 mark – on pullbacks, in other words. But I do not see huge returns in the short-term, unless there is some kind of weather-related disaster, which causes another spike (many speculators are attracted by extreme weather).

I see further consolidation still after the events of 2008. Look how many years it took the grains to recover after the 1995-6 spike. But I also see gentle year-on-year gains as likely. And in ten years or so they could well do what stocks did in 2000, making the boom of 2006-08 look like small beer.

But sustained high prices? I'd expect that if prices go too high, governments will fight tooth and nail to get them back down again. And farmers respond to the profit motive just like anyone else. Indeed, until very recently, analysts were expecting a grain glut this year, due to a couple of decent harvest years, and farmers globally bringing more land into use. (Concerns about such a glut have since been scotched by unfriendly weather in the US and higher-than-expected demand from China – but it shows that rising prices do engender a significant response from growers).

Indeed, the characteristic of both the above charts is for periods where we see several years of doing pretty little, interrupted by sudden, violent spikes. So perhaps the strategy should be to buy, wait for a spike, sell, then look to get short.

The best way to play the grains

What's the best way to play the grains? There are exchange-traded funds (ETFs) which play the grain prices, but I do not recommend them – the cost of rolling over the future contracts against which the ETFs are levered can be a source of immense frustration and disappointment for unwary investors. Sophisticated investors might buy futures, particularly long-dated ones.

But to be honest, the easiest way to play the grains is via a spread bet. Of course this is risky, and I'll give you the usual warnings – you have the potential to end up losing far more than your original stake.

Sadly, the spread betting ethos does not lend itself to long-term buy-and-hold, which is a game I would look to play for the grains. If you're more interested in an agricultural play that you can stick in your long-term portfolio, you should stick to the companies involved in the sector.

Until next week,

Dominic Frisby

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And for yesterday's market update, see below...

Our recommended article for today...
-Could Silver be a better bet than gold?
Gold hit an all-time high of $1255/oz this week. It’s a sure sign investors are getting more and more spooked. Read more.

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Market update

The JSE all share index slumped 0.19% yesterday. The gold mining index slipped 0.46%. Resources fell 0.37%. Banks and financials weakened 0.55% and 0.17% respectively. Industrials traded flat, down  0.03% and the platinum mining index decreased 1.73%.

London's FTSE100 shed 0.33%. The Dow Jones traded flat, up 0.04% and the Nasdaq closed up 0.35%.

Tokyo's Nikkei closed down 1.12%. Hong Kong's Hang Seng lost 1.27%.

Brent crude is currently trading at $76.10 per barrel.

Spot gold's trading at $1,210.23 down 0.11% and platinum was last quoted at $1,544.00.

And here's how the rand is performing against the major currencies:
R/$ 7.55
R/₤ 11.52
R/€ 9.62

Click here for the latest stock market news and charts.

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