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Don’t let market volatility rustle your cowherd’s profit. Here’s a rundown of some tools to help stabilize the cattle marketing situation.
June 26, 2013
It happened in April and May, and probably again since press time for this issue of BEEF — a market sitting pretty at a lofty level, before near limit-down moves in futures wiped the smile off a rancher’s face.
Five, six, seven bucks a hundred just vanish due to volatility, ruining a good price. In early spring, it was USDA’s stocks report on April 10 that boosted corn prices and buried cattle markets. Many stocker operators and cattle feeders were likely hedged against major losses via feeder- and live-cattle futures contracts. But what about cow-calf operators — a sector that lacks a true hedging mechanism?
Those with a calf crop ready for sale this fall only hope that prices return and resemble those projected early in the year by CattleFax. This spring, CattleFax forecast prices for 550-lb. calves to average about $172/cwt. this year, up 3% from a strong 2012. Of course, there’s no guarantee. Potential drought, which can impact cattle supplies and corn prices, is among the reasons CattleFax also stresses the need for price risk management.
Cross-hedging may be the answer. Matthew Diersen, a South Dakota State University Extension economist, says cross-hedging calves that will be sold as stockers this fall can be accomplished by using feeder cattle futures contracts. Options, forward contracts or Livestock Risk Protection (LRP) offered by the USDA Risk Management Agency (RMA) are also in his marketing tool chest.
A calf futures contract never caught on through the Chicago Mercantile Exchange, so feeder futures are the closest thing to it. But they’re contracts for 50,000 lbs. of 650-849-lb. steers, medium-large No. 1 and medium-large Nos. 1-2. That’s about 65 head on average. “But dividing the contract size by 550 lbs. implies that 90 head of stockers can be cross-hedged with each futures contract,” Diersen says.
In late spring or early summer, ranchers could cross-hedge their calf crops using October or November feeder cattle futures, contracts which have seen heavy volatility this spring. For example, in mid-April, October feeder futures were at $152 cwt., down about $4 in a few days, and $10 from where they traded in early March, $15 from February.
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If prices decline by October, lower returns on the cash side would be offset by gains on the futures side for cattle that were hedged. A wreck is covered. But basis isn’t.
“Cross-hedging does not fix the basis,” Diersen says. “Basis is usually not related to subsequent changes in futures price.”
Mike Murphy, CattleFax consultant, says ranchers should know their local basis trend at the time their calves are normally sold. “The basis is in a wider range relative to the calf market than the feeder market,” he says. “But it offers a range that would provide a margin.”
Basis can vary, depending on demand as well as cattle weight in relation to corn prices. “If the price of corn goes down, the basis will normally widen [between 500- and 700-lb. calves],” Diersen says.
“In South Dakota, for example, there would normally be at $10-$15/cwt. basis, or price spread, between five- and seven-weight cattle. But if corn goes up, as it did in the 2012 drought, the basis spread could go to nothing.”
Put price protection is often passed up by cow-calf producers due to the high costs of at-the-money (at the futures price) put protection. But spring saw more favorable option premiums, Diersen says. “Before, it would cost $6-$7/cwt. for an at-the-money put, but that’s been much lower this spring.”
In early June, the $150 October at-the-money put had a cost premium of about $4/cwt. That would provide an options floor price of $146, in the event of a big price drop. The anticipated basis of $10-$15 in the fall would keep prices at $155 or above. “Buying put options reduces the risk of prices moving lower, but not the risk of basis narrowing,” Diersen says.
Murphy says LRP can provide sound downside risk for the rancher. There are both LRP plans for feeder cattle and fed cattle. Feeder cattle policies insure all feeder cattle weighing up to 900 lb., even heifers and Brahma and dairy breeds. RMA says no more than 1,000 calves can be insured at one time, and a producer is limited to 2,000 cattle in a single year.
A fixed-percentage price adjustment factor is used to adjust the expected ending values and coverage price from standard-weight, beef-breed feeder cattle for various combinations of lightweight heifers or nonbeef breeds.
“With the volatility we see in the market, I’m a real fan of LRP,” Diersen says. “It’s good for a calf crop because you can insure any number of head. It automatically builds in a 10% basis adjustment for beef steer calves.”
Cost of LRP is similar to the cost of put options. Cost will depend on the range of coverage, between 70% and 100%.
After completing the LRP policy application, producers select a coverage price (RMA subsidizes all quoted premiums at a rate of 13%), endorsement length, and the specific number of head and expected target weight of cattle to be sold, says Stan Bevers, Texas A&M AgriLife Extension livestock marketing specialist.
“The coverage price is a percentage of the expected ending value,” Bevers says. “These values and the associated rates are based on the current day’s closing futures prices, volume and volatility, and they correspond to different endorsement lengths.”
Endorsement lengths are in increments of about 30 days, and can range from 13-52 weeks. Bevers says they’re seldom available for more than 34 weeks into the future. If, at the ending date of coverage, the actual end value has dropped below the selected coverage price, the producer can file an indemnity claim within 60 days.
With tight feeder cattle supplies, feedyards, stocker operators and their order buyers want calves that will perform well on feed. And many feedyards are just looking for faces at the bunk in order to keep their pens full.
They count on sale barns and video and Internet auctions to find many cattle. They also work directly with ranchers who they know will send them a quality calf crop. That’s where forward-contracting can take the sting out of volatility.
“Buyers want to capture a supply,” Murphy says. “Even though smaller producers may not be able to contract a full load, they can look for a split supply with others to help establish a forward contract.”
Of course, large facilitators, like Superior Livestock Auction or Western Livestock Auction, provide video sale services in which producers can show their calves to a host of potential buyers for a specific delivery date.
Forward-contracting for later delivery provides a marketing advantage, adds Tom Odle, a Superior consultant. “We sell a lot of calves 4-6 months out,” he says. “It’s a tremendous tool for the cow-calf man. It’s the only true hedge in the cattle industry. It’s a hedge on the current market for a forward contract without a margin call or other investment.”
A new branch of Consolidated Beef Producers (CBP), Canyon, TX, is expanding the ability of ranchers to market a calf crop. It’s called FeederCattleListings.com. “For cattle sellers, we put cattle in front of more than 200 buyers with more than 4 million head of feeding capacity,” says Casey Bradshaw, CBP member services manager, describing the marketing service.
Diersen says there can be drawbacks with any marketing program. Once an LRP plan is established, for instance, a producer is locked in, whereas an options or futures program can be exited. And forward contracts may see the sale price much lower than the current market.
But even though profits are still projected for calves, it’s important that some sort of risk management is used to protect return on investment. “Volatility is just too high to ignore,” Diersen says.
For more on LRP insurance, go to livestockriskprotection.com.
Larry Stalcup is a freelance writer based in Amarillo, TX.
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