Think commodities and you think of things like oil, gold and copper. After all, those are the products that grab the headlines: "The S&P 500 closed up 1 percent, and oil prices fell by $1/barrel."

As any student of commodities investing knows, however, there is an important commodity futures market tracking agricultural products. Farmers need a way to lock in decent prices for their crops, and the futures markets deliver that service.

Recently, agricultural commodities have started to come back into vogue. With the oil markets buried in contango, commodities investors are looking for the "next hot thing," and they are increasingly finding it in agricultural products.

Consider this: When ETF Securities launched 15 individual commodity futures exchange-traded funds (ETFs) onto the Deutsche Borse in November 2006, the one that gathered the most interest on Day 1 was corn.

The company had similar experiences in London, where the firm's agricultural products have been hot sellers. (So far, U.S. investors don't have any focused ETF access to agricultural commodities, but a number of companies are working on the problem.)

More recently, on January 5, 2006, PowerShares rolled out seven ETFs providing targeted exposure to different sectors of the commodities market: Agriculture (AMEX: DBA), Base Metals (AMEX: DBB), Energy (AMEX: DBE), Gold (AMEX: DGL), Oil (AMEX: DBO) Precious Metals (AMEX: DBP) and Silver (AMEX: DBS). After three weeks on the market, the Agriculture fund had nearly four-times as many assets ($99 million) as the second largest ETF (oil, at $28 million).

The rise in agricultural interest is curious, because agricultural markets aren't subject to the same themes driving interest (and prices) in industrial commodities. China and the rest of the developing world may be devouring any and all copper, oil and steel that's floating around, but corn? Sure, the global population is ticking up, but it's not as if we're eating twice as much corn as we were last year. According to the IMF, world consumption growth of steel rose 9.2 percent from 2001-2005, while corn demand rose just 2.6 percent.

What gives, then, with the recent interest in agricultural commodities? And are recent price jumps sustainable?

Price Chasing

One definite factor in the rising interest in agricultural commodities is the "tail wagging the dog" theory. In other cords, prices are up ... because prices are up.

Corn prices, which languished around $1.50-$1.80/barrel last year, now stand at $3.45/barrel. A doubling in price for any financial product is sure to attract attention, and the jump in corn prices is no different. (Corn isn't alone, either: wheat prices are trading at 10-year highs as well.)

Investors are always looking for the next big thing. Energy and metal commodities have been hot hot hot in the past few years, with prices for metals alone up 180 percent in real terms since 2002, according to the International Monetary Fund. Food and agricultural prices, in contrast, are up just 20 percent and 4 percent over the same time period. Investors are increasingly betting that those disparate outcomes are not sustainable over the long term.

Moreover, agricultural markets are not facing the same issues with contango that are plaguing the energy markets, and having a huge impact on investor profits.

Costlier Inputs And Supply Deficits

It's easy to make a case for agricultural prices rising. For one, prices for energy and land - two of the three big inputs into agricultural costs (water is the third) - are up sharply over the past few years.

Moreover, sustained low prices in the 1990s and early-2000s discouraged farmers from expanding production, and today, the world's farmers are falling behind the demand curve for agricultural products. Worldwide consumption of grain in 2006 is expected to exceed supply by 61 million tons, marking the sixth time in the past seven years that there has been a shortfall in grain production. We've been feeding that deficit with stored grain, but our grain elevators and warehouses are increasingly barren: world carryover of stored grain crops has fallen to 57 days, the lowest levels since the early-1970s.

The Energy Crunch

Higher input costs and supply deficits set the stage for rising prices, but the key factor driving interest in agricultural products - and particularly corn - is energy. Or to be more specific, ethanol.

Financial pundits, politicians and Iowa corn growers alike are quick to tout ethanol as the cure to high energy prices and the U.S.'s fretful "addiction to foreign oil." Both the U.S. and other countries have set aggressive goals for ethanol growth. The U.S. currently has 4.8 billion gallons of ethanol-making capacity, but plans to expand that to 7.5 billion gallons by 2012. And China plans to expand its ethanol production by 1,500 percent between now and 2010, from very little to more than 1 billion gallons per year.

The pace of growth is incredible: in October 2006, construction started on a new ethanol distillery somewhere in the U.S. every three days (World Ethanol and Biofuels Report, 2006).

The impact of rising ethanol demand of corn and other agricultural products is significant. Currently, the U.S. ethanol industry consumes 20 percent of domestic corn production; that number will grow to 40 percent by 2012, according to Iowa State economist Robert Wisner.

Conclusion

Historically, the price of agricultural commodities was driven by the cross-hatch of rising farmer productivity and negative one-off events. A drought in the heartland could lower yields and boost prices one year, but there would be no secular change in supply/demand to alter prices over the long-run. As long as the rains came again, prices would drift back down.

But the huge surge in ethanol demand on top of an existing supply deficit for basic grains (driven by sustained low prices during the 1990s) has changed the game, and some people see a sustained uptrend in agricultural commodity pricing stretching out for years to come. Globally, the U.S. consumed 73 million more tons of grain last year than it produced. With a further 40 million tons in ethanol demand coming on, it's easy to see why people get excited.

"We've never been in a position where we've seen this much new demand for a commodity," said Gary Schnitkey, a farm financial management specialist at the University of Illinois, in an interview with Townhall Talk Radio.

It's important to remember, however, that different dynamics are at work in the agricultural field than in the industrial commodity markets. For one, product supply is more elastic: it's very difficult to find new oil deposits, but it's mighty easy to plow a new field if the prices support your project. Already, farmers around the world are responding to increased supply by boosting their production - U.S. corn farmers are planting an additional 10 million acres of corn in 2007 compared to 2006, for the largest corn crop ever.

That kind of action may keep prices in check, even if demand grows as expected.