For investors in the agriculture sector, the continuation of one of the worst droughts in U.S. history is providing all sorts of opportunities to profit. The lack of rain has already pushed up corn, wheat and other grain prices to near historic levels. With forecasters predicting another round of severe drought conditions for 2013, there’s plenty of potential for those prices to climb even further.

It’s also quite possible that the drought’s effects will spill over into other areas of ag.

One of the better opportunities lies within the livestock sector. Because corn is a principal feedstock, higher grain prices have trickled down to beef and hog production, causing prices in the livestock sector to skyrocket. Add in exploding demand from emerging markets, and you have a recipe for outsize gains in the year ahead.

Even if you’re a vegetarian, beef should be in your portfolio.

Withering Plains

The worst drought to hit the Great Plains since the Dust Bowl has resulted in the smallest U.S. cattle herd since 1952.

The drought has recently pushed corn prices four-year highs. That’s making it tough for producers of cattle, hogs and chickens to turn a profit. Feed corn that cost only $3 to $4 a bushel a year ago has nearly doubled, and now stands at around $7 a bushel. Producers are certainly feeling the squeeze. So much so, that several meatpacking plants have gone dark. Private agricultural giant Cargill recently closed a 2,000-employee beef facility in Texas, thanks to the years of drought.

Lack of rain has compelled producers in Texas, Oklahoma and surrounding states to dramatically draw down cattle numbers. Analysts expect U.S. beef production this year to decline to nearly 24.6 billion pounds, down from 25.7 billion pounds in 2012. Likewise, pork production will fall to just 22.94 billion pounds.

Overall, that works out to be about 55 pounds of meat per person. That isn’t so bad considering the average American eats about 41 pounds of beef a year. But it is when you factor in how dietary habits are changing among emerging market consumers.

You Want Fries With That?

While U.S. is culling herds, rising demand from China, Latin America and other developing markets grows unabated. Rising living standards have a dramatic effect on diet. Put bluntly, the more change in your pocket, the more you want a hamburger. And those newly minted middle-class citizens do want their hamburger.

For example, Chinese citizens in 1977 received about 40% of their caloric needs via rice. Now, rice accounts for only about 25% of the Chinese diet. Over the last decade, as China’s economy really got cooking, its citizens’ meat consumption leaped by more than 20% per person.

And there’s plenty of room for that to grow. The emerging world’s population is roughly 10 times that of the U.S. Despite the demand surges, consumption of protein there remains at a fraction of what the developed world eats per capita. But it won’t stay that way.

This is why livestock prices are currently hovering around 25-year highs. The combination of the current drought plus long-term demand from developing markets is creating an interesting supply-demand equation. Analysts predict that cattle prices will rise in 2013, hitting into the mid-$130 range this spring. Average prices for the year are expected to reach records in the low-$130s.

Trading Hamburger for Steak

For investors, adding some steak to a portfolio could be a great tactical commodity play for next few years as the drought and rising demand work their way through the system.

One possible choice is the UBS E-TRACS CMCI Livestock TR ETN (NYSE:UBC). However, the best way to play the boom in beef is through the iPath Dow Jones-UBS Livestock Total Return ETN (NYSE:COW). With its easy-to-remember ticker symbol, COW tracks the two most heavily traded livestock futures contracts — live cattle and lean hogs. The fund weights them at 65% and 35%, respectively.

This should provide investors with plenty of exposure to rising beef and pork prices. The fund also has more assets under management and a heftier trading volume than its UBS-backed twin. Expenses for COW run 0.75%.

COW also offers the chance for investors to add a noncorrelated asset class to their portfolios. The Dow Jones Livestock Index, which the fund is based on, has a correlation to the S&P 500 of just 0.21. That means when the broad stock index zigs, COW should zag. That helps smooth volatility.

This helps explain why returns for the fund have been so-so over the last few years as the market has surged. But over the last 10 years, the index has managed to outperform the broad market.

As of this writing, Aaron Levitt didn’t own any securities mentioned here.