Lean hogs and their demand issue

August 15, 2017 10:20 AM

Lean Hog
The October contract has risen 5.25 off their lows from the 1st. This is not that unusual. As noted all last week, the market often does not like to the August expire and the next contract out hold such a steep discount to current cash prices. We can argue all we want that this discount is needed, and may, in fact, be too small based on the supply change coming, but that does not matter. From a simple optics perspective, a $20 discount is too much.

Slaughter levels in the past three weeks have risen as they always do at this time of year. They have only run 2% over last year though. They should be 3% over. Will we hit USDA's 5% over last year pork production in Q4? Allendale sees Q3 production at +3.1% and Q4 production at +3.3%.

The cost of production is still an issue here. Our model during the July AgLeaders Conference suggested $61 currently and with grain futures premiums, $64 next year. That has dropped to $60 now. This is still a concern for Q4 hogs.

Our current supply estimates suggest expirations at $84 on the August, $65 on the October, and $56 for the December. That December estimate is made with Allendale's Q4 6.851 billion lb goal, 3.1% over last year. You are looking at sub-$55 hog prices if USDA is right. For 2018 we see February at $62, April at $66, May at $72, and June with $76. We are satisfied with the hedges on hogs out through February that use the December contract. As of the open of June 5, at the equivalent futures price of 63.07 using December hog options, these hedges should be in place. As of the July 3 open, we also have feed cost hedges using December corn options. RN

Live Cattle 
The weekly Monday afternoon count of show lists came to 12,000 head over last week. Don't forget that last week's show list number showed an odd week to week decline but we ended up selling quite a few more free market cattle. Does this new number mean 12,000 more cattle offered but there are really 30,000 more? That will be something on the trader's mind for this week.

Last week's average cash cattle sale came to $115.17. Prices last week averaged from $113 to $116.50. Friday's sales and the starting point for this week ran $113. Last week's cash cattle trade was $2 lower than the previous week.

Bloomberg Newswire carried a story about the current minuscule US beef exports to China. Here's a quote to consider from the story, "Out of 600,000 head of cattle slaughtered in the U.S. each week, only about 1,600 can meet Chinese specifications), said Zhifeng Cai, a manager at the fresh produce department of Womai.com, the online retail platform of China's state-owned food giant Cofco Corp., which first imported American beef into the country. Allendale notes that comes out to 0.3%. That is quite a bit under out own in-house estimate of 1% to 3%. No matter how you cut it, the number of cattle in feedlots right at this moment that meets the qualifications are low.

Allendale sees nothing in the current NAFTA renegotiations that are threatening to U.S. beef. As a minor issue, the Canadian Foreign Minister suggested they seek to maintain their system of tariffs and export duties that protect domestic dairy, poultry, and eggs. The US agriculture community would strongly argue the dairy sector is a key target.

The weekly Oklahoma City feeder cattle auction posted prices $6 - $10 lower than last week in the mid-session update. As a reminder, feeder prices have a far different seasonal than calf prices. Feeders, those cattle 650 - 950 lbs, generally have their highest supply in the spring and lowest prices. August is the tightest offering of +650 lb. animals and therefore the highest prices. Calf prices, those 400 - 650 lb animals, have the highest supply offering to the market in the fall and are therefore almost at the year's price lows.

In the big picture rising supply, both seasonally and compared with last year is a significant problem. USDA suggested Q4 beef production would run 8.2% over last year. The four-week average is only 4.6% over last year, and we have a lower seasonal level right now. Bears will run this show through September/October.

Last week, all of Allendale's cattle price projections were filled. This was done so about two months before we see the worst of the worst of supplies. Either this market has "pre-trade" the coming bearish supply problem or the actual prices to expect in the weeks ahead will be even worse than our forecast. We don't see anything like the $97/$98 train wreck posted in Q4 of last year. However, if this market does get too far into undervalued territory in the tough spot up ahead, we will be eager buyers for summer 2018 contracts.

We forecast August at $114, October at $108, and December of $110 for expiration prices. For 2018 we have February at $112, April at $119, and June at $111. For feeders, we saw October down to $142 and April at $135. For calf prices, which have a completely different seasonal, we see October sold animals at $160, currently $168, and 2018 October sold animals at $155. Those following our advice sold August cattle in the $120 - $123 range using options. We still see more pressure so would expect hedges to be rolled to the October. Feed costs should be locked in via December corn options on the July 3 open when December corn was at $3.95. That was made with a 10 cent limited risk December option strategy. RN

About the Author

Rich Nelson is Director of Research at Allendale, Inc. in McHenry, IL. Allendale is registered with the CFTC and NFA and is a member of the NIBA. www.allendale-inc.com.