The Great Grain Rush

Seven years ago, at the height of the Internet boom, Jim Rogers was telling friends to buy commodities. He remembers the typical response: "laughing and giggling" that was "full of derision." No matter that Rogers, who cofounded the Quantum Fund with George Soros, is a legend in investing circles. Commodities were hopelessly unchic after a decade of low prices. But that was then, says Rogers, 62. "Nobody's laughing now."

Except Rogers. Since 1998, when he launched the Rogers International Commodities Index, which follows 38 items ranging from silk and soybeans to gold and oil, the index is up more than 200 percent. Over the same period, U.S. Treasury bond indexes are up 72 percent, and U.S. stocks (as measured by the S&P 500) are up 18 percent. While spiking oil prices surely help, more than half of goods on the Rogers index have nothing to do with energy, pointing to big changes in the way the world is trading raw materials.

Commodities are back in vogue. In a recent Barclays Capital poll of 150 private banks, hedge funds, unit trusts and pensions, only a third now hold commodities, and none of those devote more than 5 percent of their portfolio to them. But 89 percent plan to buy commodities by 2008, and more than a third said commodities are likely to make up more than 10 percent of their total assets in coming years.

Barclays estimates that the amount of money invested in funds linked to the value of commodity indexes ballooned from $10 billion in 2000 to $55 billion by May this year, including $6 billion in March and April. For the first time in decades, commodities are becoming an "integral part" of the holdings of institutional investors like pension funds and universities, says Philip Kemke, associate director of Barclays Capital's Commodities Investor Solutions Group based in Singapore. Yale University, one of the most successful institutional investors in the world, now has more money in commodities than in U.S. or foreign stocks.

Years of underinvestment have left many commodities in short supply. Due in part to the durably conventional wisdom that stocks are the best place to earn double-digit returns, investors could not or would not put money into raising commodity production. In his 2004 book "Hot Commodities," Rogers highlights how, anywhere in the world, there hasn't been a major oil field discovery in 35 years, no new mines have opened in 20 years and the last time a lead smelter was built in the United States was in 1969. Cobus Kellerman, head of technical research at Cape Town's Optimal Fund Management, agrees: "We can create fanciful stories about everyone in India and China buying one gold coin each or something, but I would rather look at supply." With oil and some industrial metals having had a good run, many investors are now looking to agricultural goods. For five years running, the world has consumed more grain than it has produced, cutting into stockpiles.

While the trends are difficult to quantify, the interest in commodities is believed to be hurting stocks and bonds. This is the house view at Optimal, which controls $100 million in assets. The company has put a quarter of its portfolio in commodities and less in bonds. Marc Faber, an investment adviser based in Thailand and Hong Kong, says "one way to play commodities is not to buy bonds." Why? Rising commodity prices cut into corporate profits, and therefore undermine both corporate bonds and stock prices. The exception, of course, is stock in commodity companies.

Getting a full slice of the commodity action is tricky, though. Many hedge funds are opening commodity funds, but most will be available only to the very wealthy or institutions. One can buy contracts directly on mercantile exchanges, but the minimum order for, say, nickel is six tons. And one can buy stock in commodity companies, but a 2004 Yale School of Management study showed that, since the 1950s, commodity stocks have delivered much smaller returns than actual commodities. Kellerman says it's "hard for the man on the street to get in," and while other tricky sectors like real estate have come up with funds for the average investor, that has yet to happen for commodities. "I have yet to hear of housewives talking about how much they made in soybeans."

Rogers thinks this cycle will continue until 2022 at most, and will raise the number of exchange-traded commodity funds to 10,000, from a total of four today. But by then, as Rogers warns, the party will be all but over. The surest sign of the end for a bull market is when "everyone is in it."