Soft commodities are now the best-performing sub-set of the commodity bull market. It’s easy to see why. The world’s supply is withering. The demand for these precious commodities is booming in emerging markets, while the world’s crop yields are plunging, trade restrictions are suppressing supplies and the bio-fuel craze is stealing crops for energy, rather than food.

It’s the perfect storm for investors – especially when just about everything else in the investment world has continued to post big declines since last July.

Best of all, you don’t have to purchase futures and options contracts to invest in these commodity gems. I should know. I’ve been researching and recommending commodities since 2002 in my Commodity Trend Alert (CTA). So I know it’s never been easier to trade raw materials with zero leverage and no margin!

Hot Commodities for Everybody

Commodity service-providers have launched a blizzard of exchange traded funds (ETFs) over the last 12 months. These new ETFs allow both individual and institutional investors access to hot commodities like coffee, wheat, sugar and corn, to name only a few.

It’s no wonder investors have poured an extra US$30 billion into commodities within the first 60 days of the year alone compared to just US$10 billion in 1998. The boom has arrived and everyone wants a piece of the action as the dollar slides, rates plunge and emerging markets feed their bustling infrastructure and populations.

Negative Correlation to Stocks is What Makes Commodities So Tempting

Commodities, and soft agricultural commodities in particular, are not tied to stocks, bonds or currencies. They’re not correlated to any of these markets directly. Therefore commodities provide a critical asset-allocation diversification strategy to traditional portfolios.

Indeed, as global stocks plunged the first 75 days of 2008, commodities continued to hit new record highs. The soft edibles have led the charge with big gains.

Recently, commodities have started a long-awaited correction after almost seven months of blistering gains – even as global stock markets entered bear market territory. Some bears point to a “bubble” in raw materials while others exclaim the Federal Reserve will eventually start raising interest rates again to cool rising inflation, supporting the flagging U.S. dollar. I seriously doubt that.

Facts are the United States can’t afford high interest rates for the foreseeable future because the financial system is coming undone. The Fed will continue to pump massive amounts of credit in the system. Bernanke and his boys will continue to bailout institutions that they believe pose a systemic threat and they’ll do whatever they can to act as lender of last resort in the worst financial crisis since the 1930s.

This Isn’t the NASDAQ – or the Volcker Fed

“Commodities in the 2000s are what the NASDAQ was to speculators in the 1990s.”

That’s a common misperception placed about commodities today because people assume that because the gains have been so spectacular that the cliff can’t be far away. They also point to how technology stocks went wild in the late 1990s with billions of dollars chasing the NASDAQ. We all know how that frenzy ended. Eight years later, the NASDAQ still trades more than 60% below its all-time high in March 2000.

To be sure, raw materials have enjoyed spectacular gains since bottoming in late 2001. Some sectors, mainly the base metals, are overbought. You should avoid these few overbought sectors, and possibly short them using reverse-index ETFs. But the rest of the complex, despite posting big gains lately, remains well below its inflation-adjusted highs back in 1980.

Wheat is still 150% below its inflation-adjusted high, corn is 62% off and soybeans still 60% below its best level.

The main difference between technology stocks and commodities is consumption. A few billion people every day consume raw materials while tech stocks mostly suffered from a mirage of negative earnings, negative cash-flow and absurd valuations.

Thirty-five years ago, the world didn’t have China and many other emerging markets rapidly industrializing. More than two billion consumers have entered the global trade picture. Whether we like it or not, the future of capitalism lies in the east, not in the west.

If the Fed was aggressively fighting inflation, then commodities would be dangerously vulnerable. But that’s simply not the case. In fact, it’s far from reality. This isn’t circa 1980 when the Volcker Fed was busy fighting 13.6% inflation and raising rates to a crippling 21%.

Commodities feed on easy money or low rates, a declining dollar and most of all, falling production coupled by rising demand. That’s exactly what we’ve got in 2008.

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