Chalk it up as a small victory—October’s fed trade finished on a positive note. After trading mostly $98-$100 per cwt during the first three weeks, the month’s final week of business saw the market turn higher, settling at mostly $104-$105. The jump evened the market with September. Better cash prices were largely spurred by positive trading action at the CME as the October Live Cattle contract approached expiration.
While cattle feeders welcomed the stronger market, it’s a small victory considering the longer-run trend. Since March, when fed cattle traded at nearly $140, it’s been a steady grind lower. Even with the better trade at month’s end, October marks the seventh consecutive month (April through October) with lower average fed prices.
That downward channel is well defined (Figure 1) and will be tough to fight through. Robust supplies across all protein sources and absence of any major demand-changing driver will likely keep a lid on upside potential.
That reality is baked into the deferred live cattle contracts. While there’s been positive action at the CME in recent weeks lifting prices off their recent lows, futures traders aren’t exactly in rally mode (Figure 2).
Relative positions among the commercials and non-commercials have narrowed in recent months. Often the misperception is that speculators (not to be confused with high-frequency trading) have been strongly on the sell side of the market and thus the dominant force in the long-run negative trend.
That isn’t the case; non-commercial positions have collectively been on the long side of the market. Conversely, the commercials have maintained an aggregate short position since mid-March (Figure 3).
Regardless, market fundamentals have been such that packers have experienced unprecedented returns in recent months. Depending upon your perspective, that profitability cuts both ways. On one hand, it indicates an absence of leverage on the sell side. Cattle feeders have been willing sellers, hustling to market cattle for fear of even lower prices in coming weeks and months.
However, on the other hand, it’s incentivized throughput, thereby keeping the feeding sector relatively current. And it also provides some cushion for packers to bid cattle higher and still maintain positive margins in coming weeks.
With that in mind, as the market transitions into the holidays, the calculus surrounding weekly kills, cutout values, fed prices and respective margin will need to be monitored carefully. Shifting values will serve as indicator of where leverage, and subsequently the market, might be headed.
All that said, cattle feeders have work ahead of them. First, the fed market is following cues from the wholesale market. The cutout has traded lower almost every week since March, pulling the fed market with it. Second, despite active marketings in recent months, USDA’s October Cattle on Feed report came in nearly even with last year’s number, remains bigger than 2013 and 2014 and just 2% behind the five-year average. The report was generally viewed as bullish. So while feedyards remain relatively current, as noted last month, “the pipeline could clog pretty quickly if marketings don’t remain active through the fall.” And thus, feedyards aren’t necessarily in a position to simply wait for the market to come to them.
That discussion inherently leads to subsequent influence on the feeder cattle market. This week’s Industry At A Glance highlights the year-over-year increase in feeder cattle availability. Most notably, “Despite better placement action through much of 2016 to date, total placements through September are up only about 800,000 head. In other words, given the starting inventory of an additional 1.3 million head, feeder cattle carryover into the final quarter of the year is equivalent to about 500,000 head.”
Bigger inventories, coupled with an extended streak of negative closeouts (Figure 4) are beginning to take hold and pressuring the feeder cattle market. Last month, Industry At A Glance highlighted the difference between the CME Feeder Cattle Index and deferred fed futures. In early 2013, the 26-week moving average settled around $7.50 per cwt; alternatively, the spread peaked in late 2014 at nearly $85 per cwt as feedyards were betting on the come.
However, the difference has declined in recent months and finished October at $20 per cwt (Figure 5). In light of the long-run historical norm and current market dynamics, the difference will likely be squeezed even further in coming months, thereby limiting prices on the feeder cattle side (Figure 5).
Shifting gears, I recently had opportunity to hear David Widmar, Agricultural Economic Insights, speak at the LMIC Industry Outlook Conference. During his presentation, he referenced Howard Marks, renowned co-chairman, OakTree Capital; Marks regularly provides market insights. One of Marks’ recent memos is titled, “What Does The Market Know?”
In light of the recent market downturn and continued volatility some of Marks’ observations seem applicable to the cattle market:
So what does the market know? First, it’s important to understand for this purpose that there really isn’t such a thing as “the market.” There’s just a bunch of people who participate in a market. The market isn’t more than the sum of the participants, and it doesn’t “know” any more than their collective knowledge.
With that thought in mind, it’s always useful to be reminded that these markets can prove to be challenging—both financially and emotionally. It’s critical to remain disciplined within the framework of a pre-determined marketing plan—thereby removing emotion from the decision making process. To do that successfully, producers must ensure they remain focused on objective analysis of both the market and their respective operations.
Nevil Speer is based in Bowling Green, Ky., and serves as vice president of U.S. operations for AgriClear, Inc. – a wholly-owned subsidiary of TMX Group Limited. The views and opinions of the author expressed herein do not necessarily state or reflect those of the TMX Group Limited and Natural Gas Exchange Inc.