In Part 1 and Part 3 of my last series of articles, I discussed the way that commodities have been the hot sector for institutional investors seeking a safe haven against a falling dollar and a loss of faith in the stock markets.

Today, I want to take a closer look at the reasons why this sector has been–and still is–the place to be.

First, commodities usually rise on the back of inflation, so they are a hedge against it while other traditional assets tend to lose their value. Consequently, they have attracted a large flow of speculative money, which further drives up prices.

Second, thanks to the emerging effects of peak oil (and soon after, peak natural gas) the rising cost of ever-diminishing oil and natural gas–which is the key feedstock for commercial fertilizer–is driving production costs up.

Third, the worldwide effort to supplant diminishing petroleum-based fuels with biofuels has had the unintended consequence of reduced plantings of food grains. Paul Krugman’s recent article on this point was trenchant: “You might put it this way: people are starving in Africa so that American politicians can court votes in farm states.”

Since food demand is remarkably inelastic, the reduced supply translated directly into higher prices.

Fourth, the emerging middle class of China is trying to follow that of the U.S., not only in terms of car ownership and the acquisition of material goods, but in a diet that is increasingly consumptive of meat. It takes 2x the weight of a chicken to raise it on grain, and 7x the weight of beef. Going from a diet that depends on grain to one based on meat protein is putting an enormous pressure on worldwide grain supply.

But perhaps more importantly, the world has entered an unprecedented era of shortages in fuel, food, water, metals, building materials…actually, just about everything that gets consumed. Richard Heinberg’s new book beat me to it: It’s “Peak Everything.”

Today’s shortages are unprecedented in the sense that in the past, food shortages in particular were typically local phenomena, due to unfavorable weather, wars, and the like. Now, food availability is a global problem, and weather–such as the recent drought in Australia–has certainly has played a part in that.

But the more fundamental reason is that there are just too many mouths to feed.

Or as I like to say, “there are just too damn many ticks on the hog.”

A big part of the problem is a lack of available farmland to satisfy growing populations and their encroaching urban footprints. A representative of the Phillippine National Rice Farmers Council recently told Al Jazeera, “The population of the Philippines is growing, now its 87 to 90 million people. But the use of land for rice is shrinking. The government has not prepared for this dilemma.”

According to the United Nations, the annual growth rate of cropland worldwide fell to 0.1% in the last decade, down from a rate of 0.3% that had held since the early 1960s.

Grains In Desperately Short Supply

For the vast population of the world’s poor, food costs represent over half of the household budget. And about half the world depends on rice for the majority of their daily caloric intake.

For you and me, a fifty-cent hike in the cost of a bag of rice is an inconvenience, but for them, it’s becoming a question of whether or not they’ll eat, period.

The recent spike in the cost of rice has been blamed on surging demand in Africa, the Middle East, and Asia. China and India, the world’s two greatest growth economies with some of the world’s largest populations, have both recently become net importers of rice.

The rising demand has driven the world’s rice stocks to their lowest levels in 30 years-less than half of where it stood in 2000-prompting the UN Secretary General to warn of millions facing starvation. Meanwhile, the U.N.’s World Food Program issued a worldwide distress call for more funding, just to maintain their current roster of dependents.

And we now have a mere five days’ worth of corn in storage worldwide-the lowest level ever.

Wheat inventories are at a 30-year low. Stores in the European Union have plunged from 14 million tons to a mere 1 million just in the past year.

In general, global reserves of grain now stand at a mere 1.7 months’ worth of consumption…down from 3.5 months in 2000.

Consider this small recent sample of the real pain being felt in the developing world over the skyrocketing cost of rice:

• Cambodia joined Vietnam, India, and Egypt in curbing or halting outright their exports of rice, fearing that they won’t have enough to feed their own populations. They blamed the recent rice price hike on surging demand in Africa and the Middle East.
• Residents took to the streets of Jakarta to protest the high price of rice, and rice hoarding was reported across Indonesia.
• Manila’s top 100 companies were forced to begin rice farming by the central government, and the president of the Philippines was reduced to begging Vietnam, the world’s second-largest rice exporter, to sign a rice supply agreement. Widespread hoarding of rice has been reported.
• In Thailand, the world’s top rice exporter, rice farmers are hiring guards to protect their crops from bandits. Over 90% of the country’s rice crop now goes to domestic consumers.
• Panic buying of rice in China sent prices soaring, prompting Chinese Premier Wen Jiaobao to take the unprecedented step of guaranteeing rice supplies to Hong Kong and Macau, and issuing a public statement assuring the nation that its supplies of rice were adequate.
• Riots broke out in Mexico over the price of rice (just as they did last year, over the price of corn for their staple food, tortillas).

Similarly, Russia, Ukraine and Kazakhstan are circling the wagons to protect their own supply of wheat, by restricting imports and raising export tariffs. The chief of a major Russian grain producers recently told Reuters that his country “is in a condition that has never happened before.”

Priced Out of the Market

As prices have risen, the poor are simply getting priced out of the market. Average prices for rice have doubled over the last five years, and have high a 20-year high this month.

The price of medium-grade Thai rice, a market benchmark, has skyrocketed from $360 a metric ton at the end of 2007, to $795 a ton last week, and is expected to hit $850 this week, and $1000 over the next three months.

For the hard-pressed poor, this is nothing short of a disaster.

Take Myanmar. Once the world’s top rice exporter, it’s now selling its small surplus to the highest international bidder. Like Nigeria with its cursed oil wealth, the spoils of the nation’s harvest are mainly enriching a small corrupt dictatorship, while its own people go hungry

But as I indicated in my previous article, the cost inflation of commodities hasn’t been limited to rice. Corn, wheat and soybean futures all set new records on the Chicago Board of Trade this year. Corn has nearly tripled in price in three years. Spring wheat quadrupled in a year (and has since become increasingly hard to get), and soft wheat doubled. Soybeans have tripled in about a year.

According to recent U.S. Labor Department statistics, here’s what food prices in the U.S. have done in the last year:

· Milk: +17%

· Cheese: +15%

· Rice and pasta: +13%

· Bread: +12%

· Eggs: +62% in the past two years.

The worldwide story is even worse. According to the United Nations’ Food and Agriculture Organization (FAO), here’s what happened to the worldwide cost of food during 2007:

· Grains:+ 42%

· Edible oils: +50%

· Dairy products: +80%.

We have talked much in these pages about the 60% rise in crude oil over the last three years. But compared to the cost of food, crude is a cakewalk!

No Relief in Sight

Until the worldwide push for biofuels subsides, and the balance of global tariffs and subsidies for globally traded commodities is revised, it appears that we’re in for more of the same.

The USDA recently predicted that global rice production for 2007/8 would fall three million tons short of demand, even while global rice stocks stand at 4% below last year–the lowest level since 1984.

The spell of rough weather over the previous months doesn’t bode well for this year’s crop, either. Floods and heavy rains in Bangladesh, India, Indonesia, Vietnam, North and South Korea, and the Philippines all put the hurts on their crops. The coldest winter in recent memory in China, coupled with water shortages, will put a dent in their production this year too.

Some market analysts are even warning that prices are actually still very low. When adjusted for inflation, they observe, real prices for agricultural commodities are at a 50-year low!

The Food and Agriculture Organization (FAO) of the United Nations recently observed that current commodity prices are actually much lower than they were in the 1970s, and are only just on par with the levels of the 1990s, during the Asian financial meltdown.

“We believe grain prices in general, especially wheat and maize, have been exceptionally low for a long time. It’s a reflection of the way the U.S. and Europe encouraged surplus production. This discouraged developing countries from producing food because they couldn’t produce at subsidized prices of industrialized nations,” an FAO spokesman remarked.

The reduced value of agricultural land, and falling prices for its products, has pushed the world to the brink.

How to Profit from the Commodity Crunch

At this point, I can already hear you grumbling: “OK Chris, enough of the doom and gloom. How can I profit from this?”

Well, I’m gonna tell you…next week.

I’ve been poking around looking at some good options for agricultural plays of various kinds, and I have a nice little handful assembled. I also have some skin in the game myself.

OK here’s a little teaser: I recently re-established my old position in Mosiac (NYSE: MOS). Take a look at that YTD vs. the averages and ask yourself: What’s not to like?

We might even recommend buying a few of them in an upcoming edition of the $20 Trillion Report.

Until next time,

–Chris