"They have figured out this is a place in the investment landscape where they really need to be."

After a price explosion in commodities like copper, funds are turning their attention to crops. Long perceived as too risky for the serious investor, they are finding new markets in making ethanol and biodiesel, the new "green" fuels.

Record oil prices and political tensions in the Middle East have changed the picture. Crops like wheat and maize (corn) will face increasingly competing demand from traditional food makers as well as the burgeoning alternative fuel sector.

And while there may be short-term blips -- funds have recently sold off sugar due to a buildup in cane-derived biofuel stocks -- fund managers are positive on the medium-term outlook.

"Biofuels are going to be a big theme in the markets in the near future, the next 3-5 years," said Domenic Carratu, Managing Director of Commodities and Weather Derivatives at Rabobank.

"The extra demand created by the need for biofuels is over and above the existing need for these commodities for food or food inputs. You have a much larger demand and the same sort of supply and that's going to lead to demand pressure on prices."

The new funds typically invest in baskets of commodities or indicies linked to US futures, where liquidity is deeper.

"If you're creating a US$100 million ethanol plant, you probably want 3 to 4 years' hedging," Carratu said.

"There's suddenly a lot more people interested in long-dated corporate hedging. Those sorts of things indicate to us there's a fundamental shift happening in the market."

EUROPE LAGS THE US FOR NOW

Despite the US focus, Europe's grain markets have also benefited from an increase in investment activity as prices have risen on concerns over heatwave damage to this year's harvests.

Euronext.liffe said Paris milling wheat futures hit a record monthly volume in July at 37,860 lots, a figure still small compared to turnover in the Chicago markets.

Options also hit a monthly record at more than 5,000 lots.

Rapeseed futures have also been heavily traded with a daily record of 3,308 lots traded on July 5, the exchange said.

Despite a lack of volume in Europe, some big funds have exposure to Paris rapeseed futures, and the picture is changing.

"The liquidity in all these markets is growing astronomically. They've lagged the other commodity markets in terms of development in both prices and liquidity but I think liquidity is finally coming in," Carratu said.

Low volumes aside, some analysts said over-regulation in Europe also hindered investment inflows.

"I'd love to trade wheat in Paris, if only the political environment would change to favour that," said Christian Gerlach, analyst at Swiss-based Diapason Commodities Management.

"With the Common Agricultural Policy (CAP), the structural environment is not really favourable towards investments."

Diapason has around US$5 billion in commodities' investments with US$500 million in an agriculture-oriented fund.

NOT JUST BIOFUELS

While most fund managers cite biofuels as the primary driver, others say there is a compelling case for agricultural commodities based on other fundamental scenarios.

"You have structural forces now in place for most of them, meaning you have deficit supply/demand markets," Gerlach said.

"It's a demand-driven story. Biofuels are huge, but there is a more fundamental, structural story too."

Benjamin Louvet, chief investment officer at Paris-based PRIM Alternative Investment, said the company's basket of biofuel-oriented crops was also a play on two other investment strategies, including a future rise in Chinese demand.

PRIM has some US$85 million invested in commodities with currently some US$5 million in agriculture.

"The second strategy is that by investing in food products, we also have a play on a demographic evolution, and can bet on the development of new markets," Louvet said.

"We can use wheat and corn for this as we see China increasing this kind of consumption in the future," he said.

The third strategy was linked to projected higher investment in water supplies that are heavily used in crop cultivation.

"Soon we will have to invest in water and cereals will go higher based on those rising costs," he said.

And analysts see more fund involvment in the sector ahead.