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A customer pushes a grocery cart through the food aisles at a Sainsbury's supermarket, in London Colney, U.K., on Friday, Feb. 29, 2008. (CHRIS RATCLIFFE)
A customer pushes a grocery cart through the food aisles at a Sainsbury's supermarket, in London Colney, U.K., on Friday, Feb. 29, 2008. (CHRIS RATCLIFFE)

TheStreet.com

How to cash in on commodity inflation Add to ...

It would be wrong to argue that the protests in Egypt have been economically based. It would be equally wrong to argue that they've solely been political in nature either.

Commodity inflation has been an incendiary component to the outrage pouring out into the streets in Egypt as well as the cause for the Jordanian king to replace his government. New index funds, ETFs and ETNs, as well as managed futures products and discount commodity trading providers, all give access to the fast-moving price motion of food and other commodities.

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These financial influences have been hypercharging the price motion of basic foodstuffs. Flooding in Australia, droughts in Russia and China, and reduced crops from India and South America are the fundamental supply challenges in wheat, corn, cotton and coffee and cannot be denied.

It is also undeniable that the quick action of investors and traders looking to capitalize on the price motion from these fundamental events has inflated the moves from them : 75 per cent in wheat , 84 per cent in corn , 85 per cent in coffee and an incredible 151 per cent in cotton in the last year alone.

Speculative forces have quite simply swamped the small and delicate commodity markets that have never been designed to accept this kind of investment and trading interest -- another $80-billion (U.S.) of commodity index money has poured into funds, bringing the temporary total to a whopping $350-billion according to Barclays.

Another estimated $25-billion in futures-based ETFs and ETNs have accumulated in the last two years, with more of these stock-like funds starting up seemingly every day. The numbers for personal futures accounts and managed futures funds are also increasing, although the numbers for these are a little more difficult to obtain and gauge.

But the point of all of these inflows of money is clear: As I point out in my upcoming book "Oil's Endless Bid," out from John Wiley in April, the vast majority of this interest is LONG-ONLY -- most every one of these investors and traders are looking to buy, and only buy. Everyone wants a commodity investment in RISING prices, only the most hardened futures professional ever considers going short.

The boom/bust cycle that derives from such one-way investment in price creates the incredible volatility in prices we've seen in food commodities. Not surprising considering we've so recently seen this movie play out before in oil in 2008: prices went up five-fold from 2003-2008, reaching $147 a barrel, only to collapse in eight months down to $32 and again increase three-fold to close to $100 today.

It is a scary and destabilizing movie to watch play out in emerging and third-world nations, but from an investor's view, difficult to ignore -- big gains in alternative and derivative asset classes like food commodities drive more and more interest and more and more money in, and are a useful diversifying tool -- you need to be involved.

Of the many ways to invest in the food inflation we've seen, the risk profiles are what separate them. Indices and managed futures are slightly less risky than the ETFs for grains and soft commodities, which include the iPath Grains ETN , the iPath Coffee ETN and the iPath Cotton ETN .

For all of these and other commodities, I much prefer to recommend stocks as proxies for the price action of underlying commodities -- in grains, Archer-Daniels Midland , Potash and even Deere are stocks that have benefited and have tracked closely with food commodity inflation.

The volatility created by investors and traders in food commodities doesn't seem to be ending any time soon. You need to be engaged in these in a way that correctly measures your risk tolerance and need to diversify.

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