August 8, 2019
July proved to be another good month for fed cattle prices. The market didn’t improve dramatically but it did gain some ground, all the while cutout values were drifting lower. That’s a positive turn, given we’re in the heart of a summer market and working through some big volume.
Looking back, June closed the month at $110 per cwt. But prices jumped to $111 at July’s outset. And then the fed market tacked on another $2-3 from there and largely traded $113-114 over the next four weeks. Meanwhile, the Choice cutout worked in the other direction and slipped from $219 around the Fourth of July to mostly $213 for the remainder of the month.
July’s fed steer average is about $1 ahead of last year’s market. What’s more, it comes on slightly bigger production in 2019 vs. 2018. Weekly beef tonnage in 2018 averaged 501 million pounds, but bumped up against 504 million pounds in 2019.
More product and stronger prices are a winning combination. July’s move higher looks even more favorable considering cattle feeders have consistently been sitting on big inventory.
The July 1 on-feed inventory totaled 11.485 million head, a new record for July in the series and the fourth consecutive month for a series record. Meanwhile, the 120-day inventory was pegged at 4.076 million head – also a July record and 11% ahead of the five-year average.
Feedyards are current
Cattle feeders, though, have been highly disciplined about marketing cattle and have remained relatively current. That’s partially due to higher feed prices – the feeding sector has been incentivized to market cattle on a timely basis. Hedging strategies have also played an important role in keeping up with front-end supply.
That brings us to the issue of the cutout. As noted last month, the cutout has bounced about $10 on either side of the $220 mark since last fall. Moreover, “If the cutout can reestablish support at $210-215, that’ll provide a target for a fed bottom/worst-case scenario from here.”
And that seemingly has indeed occurred. As noted above, the cutout established support around $213 during July; assuming that level stands firm, the market has built a base of support to work from going into late summer and early fall. And a better base versus last year (Figure 1).
Then there’s the futures market
Shifting back to the issue of the importance of hedging, late last week I ran across two separate items on a single day with respect to risk management in the beef industry. Both caught my attention given risk management was a recent focus for a series of Industry At A Glance columns.
The first item portrayed hedging as unwieldly and argued the industry was “broken,” largely because of the futures market. The commentator explains:
“The problem is your packers are so big…they don’t need a futures market. And they can just use contracting, out-front formula sales…they got about 85% of their needs already filled. So what do they need the futures market for?
“And for them to take a position where they need to be going long, that supports the market…that’s the last thing they want to do…they don’t want the market to go up as a whole because then it’s going to cost them more on all those contracts and formulas and everything they’ve got out there.
“So the only people you have to go long are your funds and speculators…and they don’t always want to be long – it’s so much easier for them to be short, too, because the industry is putting so much pressure on itself taking short positions to manage their risk being long in the cash market.
“You always have to depend on these speculators, these fund managers; they love the cattle futures because it’s a shallow pool and then they can kind of manipulate it and kind of make it do what they want it to do. But what we’ve got is now, we’ve got a lack of longs. Nobody wants to be long…."
The various misperceptions in that statement need to be unpacked:
“Packers … don’t need a futures market.” That’s just false; packers consistently utilize futures/options for risk management. In fact, one of the Industry At A Glance columns highlights producer position trends (futures and options). The producer long position has consistently hovered between 50,000 to 100,000 contracts at any given time during the past 10 years.
“…going long, that supports the market.” Futures markets do NOT work like equity markets; an unlimited number of contracts can be written, versus a fixed number of equity shares for a publicly traded company.
Therefore, the concept that if packers go into the futures market to purchase contracts will necessarily drive the market higher is flawed. That happens only if there is some semblance of scarcity – i.e. a limited number of contracts, or in the case of equity markets, a limited number of shares.
“You always have to depend on these speculators…” That’s shouldn’t be portrayed as negative. To the contrary, it’s the very foundation of hedging. A producer wants to transfer risk to a speculator. I explained it like this in the futures market series discussing the difference between hedgers and speculators:
To that end, futures market theory works as follows. Speculators act as insurance providers enabling hedgers to get price protection. The speculator (non-commercial) takes a long futures position with expectation that price in the future will rise.
The hedger on the other side wants to avoid downside price risk - he/she buys insurance from, and transfers risk to, the speculator. That happens by selling a contract at some given price below the “expected” price of the commodity in the future. Otherwise, the hedger cannot induce the speculator to assume a long position – the discount being what the hedger pays the speculator for assuming risk.
“Speculators … fund managers … love the cattle futures because it’s a shallow pool…” Wrong again. Fund managers do NOT favor trading in a shallow pool. Rather, they prefer big markets with lots of volume – that’s what assures liquidity.
“Nobody wants to be long…” The data do not reinforce that statement. For every seller there must be a buyer, and for every buyer there must be a seller – otherwise, a contract can’t be written. The volume of options and futures contracts for hedgers on the selling side has roughly doubled since 2010 – that wouldn’t be possible if there weren’t longs on the other side.
Conversely, CattleFax CEO, Randy Blach provides the accurate industry perspective. He spoke to Ron Hays, Oklahoma Farm Report, on the significance of risk management to the industry. Blach noted that, “…when you look at what we’ve accomplished year to date - the industry has done a good job at risk management.”
And he reinforced hedging was at its highest level in 10 years—so much for not being able to find longs in the market—and its importance to cattle feeders: “…producers took some of those profit opportunities [by hedging] and I think cash to cash losses are probably a little bit overstated when you take into account the risk management.”
Hays asked Blach about the feeding industry’s increasing implementation of risk management over time. The response: “It’s been a major, major change…People are willing to take singles and doubles instead of swinging for the fences….”
It’s also important to reinforce the importance of risk management to the overall market. As alluded to previously, hedging helps make disciplined marketers. And that’s largely buffered against uncurrentness in the face of record-large feedyard inventories.
The discussion above, and recent developments around trade, highlight the importance of objective, data-driven information. Time and effort acquiring and reviewing such information is essential! It leads to increased likelihood of good decision-making and laying the foundation for business success.
Speer serves as an industry consultant and is based in Bowling Green, Ky. Contact him at [email protected]
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