This chart blew us away. Stock prices are supposed to move at random. So how do we explain such a seemingly orderly pattern? To answer this question you have to also consider the cyclical movements of commodities prices. Take a look at the chart below. It shows the trend in commodity prices between 1982 and 2000 – an 18-year upswing in equity prices.

As you can see, commodities entered a secular bear market just as equities entered a secular bull market. And vice versa.

The reason for this is actually relatively simple. As costs for raw materials increases corporate profits decrease. Eventually, the decrease in profits causes demand to fall for commodities… and prices fall.

This fall off in prices then reduces investment in the acquirement and production of raw materials, which in turn reduces supply. As supply gets tighter prices begin to rise again. Investment in commodities becomes once again profitable, and the cycle completes itself.

This story gets really interesting when you consider that during the vicious sell off in commodities last year prices bottomed far higher than in previous recessions.

According to Rosenberg:

In the 2001 recession, the oil price bottomed at $19.33/bbl; in 1990, it bottomed at $16.81/bbl; in 1982 at $28.48/bbl; and in 1975 at $10.11/bbl. We bottomed this cycle at levels that were peaks in prior cycles. The same holds true for copper – it hit its trough at $1.39/pound this time around versus $0.630 in 2001 and $1.00 in 1992. Ditto for the ‘softs’ – soybeans bottomed at $8.48/bushel this time, compared with $4.15 in 2001, $5.42 in the recession of the early 1990s and $5.32 in the early 1980s downturn.

What does this mean for your investments? Put simply, this implies that “the floor is in” for commodities. Consider adjusting your portfolios accordingly.

I’m not talking about the increases in daily staples that make the front page, but those little extras that make daily life just a little bit sweeter – coffee, cocoa and sugar.

We might not need them, but we definitely want them. And inflation is putting upward pressure on the price of these soft commodities just as it is on oil and grains such as wheat and rice.

Coffee is Big Business

It doesn’t take an investment expert to realize Americans love their coffee. It’s no longer a drink just to wake you up in the morning. Starbucks Corp. (SBUX) helped create a cultural coffee phenomenon, introducing consumers to espresso drinks. Now it seems like every city street corner has its own gourmet coffee shop selling specialty coffee beverages, often for upwards of $4 a cup.

But it’s not just the extra foam on top that is making that cup of coffee cost more. The price of coffee beans has more than doubled in the past few years.

According to U.S. Department of Agriculture (USDA) data, the New York spot price for Brazil’s Arabica coffee is up 20% over last year’s annual average of 110.72 cents per pound. Just five years ago in 2003, the annual average was only 50.82 cents per pound.

The USDA said in its recent Tropical Products: World Markets and Trade report that U.S. imports of coffee and coffee products increased 14% in 2007 to $3.8 billion. Meanwhile, exports were at a record $513 million, but that’s still a huge trade imbalance.

But there’s hope for those who are looking for a cheap cup of joe before year-end. Brazil’s 2008 coffee crop is just starting to be harvested and is already forecast to be one of the best ever, producing almost 50 million bags of coffee.

“With Brazil’s larger production this year, world coffee output is expected to reach 133.25 million bags while consumption is seen at 126.0 million. If these figures are realized, it will result in an 8.25 million-bag surplus for the 2008 crop year,” wrote James Cordier & Michael Gross, Optionetics.com. “This is not a record surplus, but it should be enough to knock prices down into a new trading range for the second half of the year.”

If coffee prices head lower this year, then the buyers of the raw beans are going to be the ones to benefit. You might want to consider:

• Green Mountain Coffee Roasters Inc. (GMCR): The bulk of U.S. coffee exports are of the roasted variety and this company is getting its share of that export action. It recently announced expected sales growth of 42% to 47% for its fiscal third quarter and reaffirmed its positive outlook for the full-year. Year-to-date, shares are up just a little over 1%, but are up 35% over the past five years. Green Mountain also owns the popular Keurig single-cup brewing system and sells many varieties of coffee to fit it.

• Starbucks Corp. (SBUX) and McDonald’s Corp. (MCD): Starbucks will likely benefit from any dip in coffee prices. Meanwhile, McDonald’s has been aggressively entering the specialty coffee arena and is set to give Starbucks a run for its money when it comes to lattes and espressos served on the go.

The Cost of Cocoa

You may have noticed that your candy fix, much like your caffeine fix, has cost you more lately. On average, the cost of high-quality chocolate, which has a higher cocoa content, has increased over 6% in the last year, according to Nielsen data.

That’s because the cost of cocoa has more than doubled since the beginning of 2007. It can be shipped in powder, paste or liquid form and commands $2,600 per metric ton on New York’s Intercontinental Exchange, up from $1,700 at the start of 2007.

And while cocoa is certainly subject to the same conditions that can affect other crops such as poor weather conditions, the huge increase in price, at least for this commodity, doesn’t seem to be a simple function of supply and demand.

For the year ending in September, the International Cocoa Organization only expects a 51,000-metric-ton shortfall, which can be made up with existing stock, The Wall Street Journal reported.

“The fundamentals do not justify this price, and I haven’t heard of any other explanation other than [investment] funds,” said Hagen Streichert, a German government official and the spokesman for cocoa-buying countries on the International Cocoa Council.

Many analysts and management from some of the leading global chocolate manufacturing firms including Cadbury PLC (ADR: CBY) and the Swiss firm Chocoladefabriken Lindt & Spruengli AG are pointing the finger at hedge fund investments. Volatile equity markets and tight global credit markets have led funds to seek out alternative investments in commodities.

“In my lifetime, it’s an entirely new phenomenon,” Stephanie Garner, a cocoa trader for Sucden, a broker owned by Sucres & Denrees SA, on the London International Financial Futures and Options Exchange told The Journal, speaking of the sudden increase in cocoa futures contracts. “It’s to a large extent a fallout of the credit crunch.”

It’s hard for the average investor to find a pure cocoa play. There are some exchange-traded funds that focus on the price movements of cocoa, but they trade in London and aren’t open to most U.S. investors. However, Africa produces most of the world’s cocoa supply, so an ETF focused on that region could be a good choice:

• SPDR S&P Emerging Middle East & Africa ETF (GAF): This ETF seeks to replicate the movement of an equity index based on the Middle East and African equity markets. The fund uses a passive management strategy to track the total return of the S&P/Citigroup BMI Middle East & Africa index.
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