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DAVID KRUSE

By Staff | Oct 7, 2016

There has been a lot of frustration this year with the cattle futures markets, mostly because they have fallen, reflecting enormous losses for the feeding industry, deflating returns seen for ranchers. While this happened, both packer and retail margins inflated.

Who got screwed by this? In my opinion it was the consumers who were taken the most, paying far higher prices for beef over the retail counter the past few months than wholesale beef prices justified.

Had the savings from lower cattle and wholesale prices been passed on to consumers there would have been a positive response from demand.

One grocery chain still had rib-eyes featured at $8.99 for 8 ounces, which would appear to me to be gouging the consumer. The consumer isn’t smart enough to figure out that that is $17.98 per pound? It’s ludicrous.

Cattle prices have gone down and consumers have not benefitted to the degree cattle prices have fallen which means that cattle prices have gone down for nothing because new demand has not been generated.

The beef industry has a demand problem exemplified in part by the poor performance of Ruby Tuesday’s restaurant chain. The steakhouse franchise is closing 13 percent of its stores (95) as revenue dropped by 6 percent and store sales fell 2.7 percent.

This under-performed the industry as a whole which is seeing no growth this year. The CEO re-signed. I see this as the belated impact of sky-high beef prices from the top of the cycle along with tightened consumer spending favoring pizza. We have near full employment and falling gas prices saved consumers an average $900 this year and they didn’t celebrate with a steak.

Beef prices have been slow to fall to engage for market share with very competitive pork and chicken prices. The beef industry destroyed demand with record high prices and now it is finding it very painful buying back that demand.

When beef supplies tightened, both pork and chicken added market share and when they made money, added still more production. There is no shortage of beef anymore and now the increasing supply has to duke it out at the meat-case with lower prices. Higher than necessary retail beef prices are counterproductive to that end. Current beef pricing is very inconsistent.

The markets have been attempting to discover pricing for what is a huge change from cycle highs to what prices it will take to repair busted demand. As has always been the case, some pick out the futures market as the culprit when it is more reflective of fundamentals than critics give it credit for.

Yes, there has been volatility and daily moves often make no sense. So what is new about that? I have traded cattle for decades and the daily moves never made sense, but the trends were there.

Just because feedlots can’t hedge cattle to make money doesn’t mean that the futures market is broken.

Feeder cattle placements were reported to be up 15 percent last month in the recent cattle-on-feed report. I doubt any of them have been profitably hedged yet.

Despite feedlot losses, they are still buying feeders that need a market to be profitable. I don’t see that the bear market has yet accomplished what it needs to, while cycles call for lows in October.

The futures market did function to mitigate risk, but the volatility shocked seasoned hedgers causing them to back away, which produced a corresponding decrease in trading volume. Trading volume tends to expand on bull markets and contract in bear markets so that was not that unusual given the bear market.

Live cattle contracts are settled by physical delivery. The problem is almost no one wants to deliver cattle and packers have little interest in buying cattle through futures delivery.

The decline in negotiated cash cattle sales has shrunk the foundation of cattle price discovery. Shrinking price discovery is like trying to balance a pyramid on its point with all the weight of the base above it.

Instability becomes inherent and is reflected in the futures market. Feedlots really can’t blame that on futures. Big lots make deals with packers so most cattle are priced via a formula of some kind and the question is now that negotiated sales have declined, what to base a market on?

The CME has been working with the NCBA which has a lot of very unhappy members who, not being able to do anything about the weak market, are focused on revamping futures contracts.

There has been discussion of moving to a cash settled contract, but there is great resistance to that, too. The NCBA opposes it saying, “We want physical delivery rather than cash settlement. Physical delivery is the way that we have been doing this; people understand how that works.”

Doing things the way they have always done them has never been a very good justification for resisting change. They want a more comprehensive overhaul of the delivery system which would be a minimum.

I think that physical delivery is like using a rotary phone. Who does that today? I think that cash settlement is inevitable and they need to put their resources into developing that kind of contract.

The industry needs to take responsibility for maintaining a cash market. The industry must work together with the CME in order to have a means to “hedge” the great risks inherent in the industry, so all players need to be integrated into the process of rediscovering an effective risk management vehicle.

I balance this with the recognition that when critics call market action “irrational” that is often their synonym for a “lower” market.

Volatility on the way up is never as alarming to them as volatility on the way down.

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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