Mike
Well-known member
Cattle: Is The Collapse Over?
My worst suspicions have been confirmed. Since my December 2005 newsletter, when 2006 futures contract prices were trading in the upper-$80's and lower-$90's, I've been questioning whether the futures market was overly optimistic. The April contract, for example, traded around $93 during December and January; it is now trading near $80. The June and August contracts also have taken large hits during the same time frame. Why the collapse and is it over?
First, how did prices get so high? The cash market rallied through the fall on optimism surrounding the potential opening of the Japanese market. It was also in this time frame that large financial companies increased their presence in commodities markets, including live cattle futures contracts. That is, these companies wanted to be able to provide investors a hedge against inflation, so they began buying commodities futures contracts in the hopes of being able to sell at a profit as they matured if prices increased due to general inflationary pressures. These companies bought many contracts of various maturities, and this buying spurt helped increase futures prices during the fall. These prices were rising despite the fact that the cattle cycle had turned and all supply projections pointed toward more beef during 2006.
The re-closure of the Japanese export market during January may have been the first turn against the rally. By then, the number of financial companies entering the market stabilized, meaning these companies were now selling futures contracts as often as they were buying, which removed the general upward motion that the funds created during the fall. This also caused rapid declines in nearby contracts when the maturation date of the contracts drew near (the so-called rollover from one maturity to another). That is all the funds want to sell, for example, April futures contracts they have previously purchased and reinvest the proceeds in, say, August futures contracts. The big question is: what happens if funds tire of inflation hedges and decide to get out of futures markets? Then they will only be selling and this will exert even greater downward pressure on futures prices.
Meanwhile, in cash markets, cattle supplies have ramped up as the year has progressed. In January, beef supplies were up by 7% compared to year previous, while first quarter supplies will be 6% higher than last year. Not surprisingly, cash prices dropped about $0.75/cwt each week during the first quarter of this year, and currently stand in the mid-$80's after starting the year in the mid-$90's. This is distinctly counter-seasonal and begs the question – is the decline over? Sadly, for feedlot operators who paid top dollar for feeder cattle last fall and winter, the answer is 'no'.
Second quarter supplies will surpass last year's second quarter supplies by at least 6% and by as much as 9%. This will cause local cash prices to decline from the mid-$80's to the upper-$70's by Memorial Day. The question then is will cash prices drop much further than the upper $70's during the summer, or will they further decline toward the mid- and lower-$70's? The answer to this may lie in some simple demand-side issues, such as whether chicken supplies moderate and whether there is movement in re-opening the Japanese market to US beef. The US chicken supply in cold storage is 45% larger than last year at this time due, in part, to global poultry aversion spurred by Avian Flu scares throughout Europe and Asia – no one wants to eat or import chicken. Coupled with normal expansion in US chicken supplies, this means there is a glut of cheap chicken in the US that retailers feel obliged to sell, and this limits attention paid to beef at the retail counter. If poultry producers reign in production quickly, this will be positive to all parties. And, obviously, if Japan ends the bureaucratic maneuvers and re-opens the border sooner rather than later, we may be able to avoid the lower-$70's during the summer doldrums.
Have futures prices adjusted low enough to accommodate for this potential surge in beef and other meat supplies? Prices for the August contract seem to be in line with demand observed last year, though April and June may still have room for downside movement ($2 to $4). On the other hand, fall futures prices seem to be rather pessimistic, with October and December prices trading about $5 below where historical demand suggests.
The declining cash fat cattle prices has caused some negative returns for feedlots during February and March, which has partially transmitted to lower prices for the feeder and cull cow markets. Only heavier feeder cattle have suffered commensurate price declines, however. Lighter weight feeder cattle and cull cow prices have remained resilient so far, but may be ripe for decline over the next couple of months. In other words, if you are holding lighter weight feeder cattle, you may want to think seriously about marketing these animals before pessimism spills over to these weight groups, particularly as corn prices ramp up, which can provide another negative driver for lighter weight feeder cattle prices. Cull cows prices often peak during May and June, but may peak earlier this year due to this negative psychology.
Brian Roe
Associate Professor, Dept. AED Economics
614.688.5777 phone/614.292.7710 fax
http://aede.osu.edu/people/roe.30/index
My worst suspicions have been confirmed. Since my December 2005 newsletter, when 2006 futures contract prices were trading in the upper-$80's and lower-$90's, I've been questioning whether the futures market was overly optimistic. The April contract, for example, traded around $93 during December and January; it is now trading near $80. The June and August contracts also have taken large hits during the same time frame. Why the collapse and is it over?
First, how did prices get so high? The cash market rallied through the fall on optimism surrounding the potential opening of the Japanese market. It was also in this time frame that large financial companies increased their presence in commodities markets, including live cattle futures contracts. That is, these companies wanted to be able to provide investors a hedge against inflation, so they began buying commodities futures contracts in the hopes of being able to sell at a profit as they matured if prices increased due to general inflationary pressures. These companies bought many contracts of various maturities, and this buying spurt helped increase futures prices during the fall. These prices were rising despite the fact that the cattle cycle had turned and all supply projections pointed toward more beef during 2006.
The re-closure of the Japanese export market during January may have been the first turn against the rally. By then, the number of financial companies entering the market stabilized, meaning these companies were now selling futures contracts as often as they were buying, which removed the general upward motion that the funds created during the fall. This also caused rapid declines in nearby contracts when the maturation date of the contracts drew near (the so-called rollover from one maturity to another). That is all the funds want to sell, for example, April futures contracts they have previously purchased and reinvest the proceeds in, say, August futures contracts. The big question is: what happens if funds tire of inflation hedges and decide to get out of futures markets? Then they will only be selling and this will exert even greater downward pressure on futures prices.
Meanwhile, in cash markets, cattle supplies have ramped up as the year has progressed. In January, beef supplies were up by 7% compared to year previous, while first quarter supplies will be 6% higher than last year. Not surprisingly, cash prices dropped about $0.75/cwt each week during the first quarter of this year, and currently stand in the mid-$80's after starting the year in the mid-$90's. This is distinctly counter-seasonal and begs the question – is the decline over? Sadly, for feedlot operators who paid top dollar for feeder cattle last fall and winter, the answer is 'no'.
Second quarter supplies will surpass last year's second quarter supplies by at least 6% and by as much as 9%. This will cause local cash prices to decline from the mid-$80's to the upper-$70's by Memorial Day. The question then is will cash prices drop much further than the upper $70's during the summer, or will they further decline toward the mid- and lower-$70's? The answer to this may lie in some simple demand-side issues, such as whether chicken supplies moderate and whether there is movement in re-opening the Japanese market to US beef. The US chicken supply in cold storage is 45% larger than last year at this time due, in part, to global poultry aversion spurred by Avian Flu scares throughout Europe and Asia – no one wants to eat or import chicken. Coupled with normal expansion in US chicken supplies, this means there is a glut of cheap chicken in the US that retailers feel obliged to sell, and this limits attention paid to beef at the retail counter. If poultry producers reign in production quickly, this will be positive to all parties. And, obviously, if Japan ends the bureaucratic maneuvers and re-opens the border sooner rather than later, we may be able to avoid the lower-$70's during the summer doldrums.
Have futures prices adjusted low enough to accommodate for this potential surge in beef and other meat supplies? Prices for the August contract seem to be in line with demand observed last year, though April and June may still have room for downside movement ($2 to $4). On the other hand, fall futures prices seem to be rather pessimistic, with October and December prices trading about $5 below where historical demand suggests.
The declining cash fat cattle prices has caused some negative returns for feedlots during February and March, which has partially transmitted to lower prices for the feeder and cull cow markets. Only heavier feeder cattle have suffered commensurate price declines, however. Lighter weight feeder cattle and cull cow prices have remained resilient so far, but may be ripe for decline over the next couple of months. In other words, if you are holding lighter weight feeder cattle, you may want to think seriously about marketing these animals before pessimism spills over to these weight groups, particularly as corn prices ramp up, which can provide another negative driver for lighter weight feeder cattle prices. Cull cows prices often peak during May and June, but may peak earlier this year due to this negative psychology.
Brian Roe
Associate Professor, Dept. AED Economics
614.688.5777 phone/614.292.7710 fax
http://aede.osu.edu/people/roe.30/index
