I am racking up the frequent flyer miles this year. My travels in 2008 have taken me to exotic locales like Singapore, Hong Kong and Dubai, as well as somewhat less exotic locales like the American Midwest. But guess what, the Midwest is the place that’s making the headlines in Singapore, Hong Kong and Dubai. The soaring price of agricultural commodities like wheat, corn and soybeans is one of the biggest news stories on the planet right now.

But ag commodities aren’t just a huge news story, they are also one of the most exciting trading opportunities of 2008 and beyond.

Whether my travels take me to the Middle East or the Midwest of the U.S., the stories are very similar. Most people are concerned about the rising costs of agricultural commodities. And they should be. The commodity boom is real. It is not a bubble, no matter how many folks wish that it were.

In fact, now you have all of these dollar bulls coming out and saying that the worst is over for the dollar and that the commodity bubble will soon burst. They say that the commodities markets are simply speculator-driven. I disagree. Do you remember as a child wishing for something, wishing so hard, yet it didn’t come true? Wishing for something to happen does not mean it will be so. (I never did get that red bike.)

The dollar will probably bounce a little higher, but the same problems that drove the dollar into the basement will persist, and even worsen. The Fed can’t just snap its fingers and wipe away a credit crisis with some stimulus checks. Too many folks are subscribing to the idea that the consumer will somehow come to the rescue and spend our way out of recession. That’s pure fantasy.

The hope that the commodity bubble will burst is also a fantasy. The fact of the matter is that we are in a new paradigm for commodities and the old-school thinking about how commodities used to be traded has to be changed. And this is true of most commodities – none more so than the agricultural ones. Sure, speculation is a part of this puzzle, but to say it’s all speculators and hedge funds that are causing the run-up is a sad mistake.

As I sit here writing this column, I am watching CNN out of the corner of my eye, and on the air is Jonathan Stevens, a baker from a Massachusetts company called Hungry Ghost Bread. He is starting to grow his own wheat and encouraging his customers to do the same. Not a bad idea. For a 50-pound bag of organic flour, he used to pay $25, but now pays around $60. So in back of the store, the bakers are now growing their own wheat. Now, while farming in your backyard may not seem very practical, it’s becoming part of a new reality: If you want to be sure you have the food you need – absolutely sure – you’ll want to grow it where you live.

Most of the world’s inhabitants already understand this essential reality. America’s are just starting to re-discover it. In fact, we’ve even made up a new word to describe this ancient necessity of growing food where you live. The word is “locavore” and it means someone who eats food grown locally. Wow! Very trendy!

Demand for ag commodities is real and it is worldwide. Meanwhile, supplies are stretched thin. So any “supply shock” has the potential to cause prices to soar even higher. A new supply shock might be developing right under our noses. The planting season here in the U.S. is getting off to a very bad start, as the weather has been awful. Torrential rains have flooded many fields, making planting impossible. The U.S. Department of Agriculture reports that only 10% of the corn crop west of the Mississippi has been planted, compared to a five-year average of 35% for this time of year.

Plantings for soybeans, spring-wheat and rice are also trailing behind their five-year averages.

Therefore, this year’s corn crop could be extremely disappointing. Some of the other crops might also disappoint. In my trading service, Resource Trader Alert , we are betting on much higher prices in soybeans and corn, and we are using option spreads to take advantage of this.

My annual meetings with Midwest farmers are always helpful. But my recent meetings with farmers in Minnesota were particularly helpful. Not only did I gain some insights about this year’s crops, I also learned a great deal about the soaring prices of fertilizers and other farming “inputs.” The long and short of it is that input costs are rising about as fast as commodity prices. So many farmers are getting squeezed.

And these rising input costs are here to stay, which probably means that rising grain prices are also here to stay. Yes, prices will fluctuate dramatically. But the bull market in agricultural commodities is very, very real.

Why deny it? Why not trade it?

Regards,

Kevin Kerr
for The Daily Reckoning

Gary lives in one of Iowa’s most productive farming counties. He helps local farmers sell their harvest using the futures and options markets in Chicago. He also makes million-dollar speculations of his own.

Gary really knows the “ag” markets. He used to be the head stock buyer in a cattle yard, he’s traded ag commodities every day for the past 40 years, and he spends all day talking with farmers.

The last time I met Gary – in November 2006 – he told me this:

“Corn is going to $5 a bushel, up from its current price of $3.33. Soybeans are going to $9, from their current $6.45. And Iowa farmland is a bargain at $5,000 an acre.”

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Today, corn is $6 a bushel, soybeans are $13, and prime Iowa farmland is $10,000 an acre.

Back then, it was obvious grain prices had to rise. They were too cheap, and with the ethanol boom in full swing, it was plain to see corn and soybean prices would rise. Now it’s not so clear…

Gary says a bad crop could send corn to $10. But that’s not likely. The farmers are planting their fields right now, and Gary thinks there’s going to be a big crop this year. That could push grain prices down.

Gary wouldn’t predict a fall or a rise in the grain markets. He can’t know the future. But he did tell me he had sold all the grain production from his own farm, locking in corn prices at $5.80 and soybean prices at $12.80.

While it isn’t clear what’s going to happen to the grains… Gary said hog and cattle prices have to rise. Here’s why:

A knife is made out of steel. The knifemaker simply turns a raw material into a more expensive “value added” product. The hog and cattle farmer does the same thing. Corn is the raw material. Hogs and cows are a value-added corn product. Think of livestock as corn bins with four legs.

When steel prices rise, the knifemaker has to raise his knife prices or he’ll go out of business. Farmers haven’t been able to raise hog and cattle prices. Years of cheap corn have built up large inventories of meat.

Now the hog and cattle farmers are going out of business. Soon there’s going to be a shortage and prices will rise. “There’s going to be drastically higher meat prices when all this washes out,” Gary said.

To invest directly in hog and cattle prices, you have three choices: You could make friends with a farmer and ask him to buy livestock for you. You could open a futures trading account and buy live hog or feeder cattle futures. (Prices are volatile. Make sure you use plenty of margin and retain a broker who knows the agriculture markets well.)

Finally, you can buy a publicly traded meatpacker like Tyson, Hormel, or Smithfield. But be careful… other “corporate” variables may influence the prices of these stocks and ruin the trade, even if livestock prices rise.

Good investing,

Tom Dyson