After declining sharply in late 2008, cattle futures recovered into an extended multi-month trading range this year.
The economic recession damaged demand for high-end beef in both the export and domestic markets. There is absolutely no reason to believe that demand is going to improve significantly from recession-reduced levels soon. Surveys of consumers found that the change in buying habits made will persist.
One could call it an adjustment from a steak to hamburger society. The employment picture is bleak. Bulls are forced to rejoice that fewer people lost jobs this month over last, but the employment picture is nasty. Workers with jobs are working fewer hours, even job sectors typically thought of as safe such as teachers, are losing their jobs. States’ finances are a shamble.
The U.S. Postal Service is laying off workers. Food stamps don’t buy much beef … unemployment benefits are not going to last long enough for the economy to pick beef demand back up. The beef industry responded to the demand problems by reducing numbers on-feed and subsequent beef production. In a sense, it worked.
Today, in September, the beef industry has returned to a marginal level of profitability. Packers, feedlots and ranchers are all paying their bills, although barely. They have a long ways to go to recover losses taken.
The problem is that the supply reduction was manipulated lower with reduced placements on-feed, with feeder cattle pastured. On-feed numbers were reduced far more than the calf crop was reduced. That means that short-term supply was reduced by backing up long-term supply.
When live cattle futures predicted a price recovery based on the “temporary” reduction in cattle on-feed, feedlots responded by delaying marketings and increasing placements of heavy feeder cattle.
Beef production is now poised to recover before demand does. That may well mean that another leg down in cattle prices lies ahead and the current recovery to profitability will be like getting a gasp of air into your lungs before diving deeper into the pool.
This period of lighter supply will be short lived. Feeding conditions are close to ideal. For what it’s worth, packers, feedlots and ranchers are all making money, not much money, but at least they are not still hemorrhaging from the bottom line like the hog industry is doing.
This was achieved through moderation of supply. The problem is that placements are climbing again and the previous reduction in on feed numbers backed up feeder cattle outside of feedlots.
Recent on-feed numbers were 5 percent lower while the calf crop was only 1 percent lower. The cattle herd needed to be reduced 5 percent, not just 1 percent to permanently reduce supply.
Available feedlot bunk space is grossly over-capacity relative to beef demand. The protracted sideways trading range in cattle saw support levels broken recently and when broken support was tested as resistance in December live cattle, it held. If demand doesn’t improve and production recovers, increasing supply again, we should see lower cattle prices. A technical breakout targets $75.
Switching to the hog market, fundamentals of burdensome supply and weak demand have been consistent and there is no expected change short-term. While both the poultry and beef industries responded to the economic recession and demand problems by modifying production, hog producers did not.
Their industry was tightly glued together with capital investment and contracts so that producers are tied into production until bankers pull the plug. U.S. hog producers expected Canadians, independent producers or someone besides themselves to quit so that they didn’t have to. The drain of industry equity is astounding.
Sow slaughter ticked up starting in mid-August, but it will take many months to liquidate the industry to the level economists have long targeted as necessary to return profitability to producers.
Bankers are now actively pursuing triage with hog producers, asking for additional collateral and reluctantly pursuing liquidation to recover assets. Little salvage value exists from production infrastructure as this unneeded capacity has little current value.
Hog producers are forced to make tough decisions whether to pledge more collateral and risk losing that too.
The hog industry was not operating a successful business plan. The industry is going to contract in 2010, involuntarily. They are literally raising hogs until they go broke. Pork has gotten cheap in the process. Wholesale ham sold near 40 cents per pound before someone decided that was ridiculous and printed the ham market near 63 cents.
Up there, interest dried up and ham values plunged again. It’s a unique kind of volatility that generates short bursts of buying that are not sustainable. Weak underlying demand has not changed and neither has burdensome supply.
Herd liquidation taking place now won’t reduce hog and pork production until well into 2010. Smithfield Foods reduced its herd 13 percent and borrowed a billion dollars, some with notes at 10 percent interest in order to outlast it.
Smithfield Foods is at least partially offsetting production losses with processing profits. The liquidation will occur from non-integrated producers that can’t borrow money even at 10 percent.
Lean hog futures are rebounding from their August low similar to what hams have done. Bear markets have corrections.
David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.
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