The bottom line, says Stephen Koontz, professor of agricultural and resource economics at Colorado State University, is this: The cattle feeding sector will continue to use more formulas and other alternative marketing arrangements at the expense of the cash market.
Here’s his question: Will the cattle business continue to move in a thoughtful process away from using the cash market as its price discovery tool, or will it be swept along by the process and have to scramble to find alternatives?
Koontz has been studying the thinning fed cattle market since 2012 to determine how thin is too thin for cash trade. His research is wrapping up, and you can find executive summaries on his website.
Nationally, he says about 20% of the fed cattle are traded on the cash market, and that’s enough to maintain price discovery. However, there are some glaring regional differences. “There are some potential problems in the Southern Plains. That’s simply a very thin cash market.”
In fact, almost no fed cattle in Texas trade on the cash market. That’s a problem, because the Texas market has historically been very strong in its ability to discover price. “If you do a little bit of cash trade there, you can have very good price discovery,” he says.
For Kansas, he estimates the cash market makes up 10% to 15% of the cattle trade, “but it depends on the week and the time of the year. The negotiated cash trade in Kansas is highly variable. It can have a particular week at 1%, and two to three weeks prior, it can be 24%.” And even with the amount of cash trade in Kansas, it may be too thin even at its present level to contribute to the price discovery process, because the Kansas market doesn’t weigh as heavily in price discovery as Texas and Nebraska.
Nebraska, which has the largest cash trade presently and leads the nation in price discovery, can also be variable, but at a much higher level. Nebraska cash cattle trade can be 30% of the mix one week and 60% a few weeks later. While Nebraska has taken the lead in marketing cash cattle, Koontz says price discovery is still tenuous because of the absence of cash trade in Texas.
So, his take on what’s needed to have sufficient price discovery in the fed cattle market is this: “If we could get something along the lines of 4% to 6% cash trade back in Texas, it would do substantial price discovery. For Kansas, it probably takes something higher — 8% to 12% [consistently], something like that.”
Colorado and Iowa don’t figure in the national price discovery process very much. Colorado has historically had little cash trade. Iowa has a considerably higher percentage of cash trade, but doesn’t contribute a lot to price discovery because the volume is relatively low compared with other cattle feeding states, Koontz says.
Reasons for decline
“When you talk with cash traders, they will say pretty clearly they’re in it for the money; they do it because they like to do it; they do it because they’re good at it; they think they’re able to push the market in their favor.”
But Koontz learned that’s often dependent on an individual person at an individual feedyard. When that person retires, the desire and ability to trade tough with the packers can leave, too. And interestingly, Koontz found that the packers would prefer to buy more cash cattle than they do. “Every packer I talked to said flat out they’d like to buy more cash cattle. They think they’re good at it.”
And that’s what makes a cash market, he says — the bid and ask, the hard work of trading tough, giving and taking to arrive at a negotiated price.
But cattle feeders have been through a wringer since drought and ethanol caused corn prices to shoot skyward, beginning in 2006 and 2007. Then, when corn prices moderated, feeder cattle prices took a rocket ride, providing a very narrow window where cattle feeders could notch some profits.
That put a cost squeeze on cattle feeders, with predictable results. “They’ve really hammered costs and hammered this idea of supply chain management, and trying to chase cost out of the system. When corn goes to $6, $7 and $8 per bushel, how can you continue to feed cattle in that kind of world? Well, you really manage your costs.”
And formulas and other marketing arrangements are simply more efficient. Cash markets can be disorderly, costly and very risky. Koontz says a lot of cattle feeders tell him they simply can’t go through the week without knowing which cattle will move and when. Packers say the same. So while there’s a desire and even the need for the industry to sell cattle on the cash market, the strong economic push for the individual is to move away from the cash trade.
“So what are formulas worth? The bottom line is, I could get people to construct a number pretty close to $25-per-head benefit,” Koontz says. “If it’s worth $25 per head, you’re not going to stop doing it. I couldn’t get folks who were on formulas to say they were very interested in going back to cash.”
Forward contracts are similar, although feedyards that use that marketing method had a hard time attaching a dollar value — because that’s just how they do business. “If you can’t do business any other way, you’re not going to stop doing it,” he observes.
Those who use cash market price information estimate it’s worth from $1 to $3 per head to them. “So, formulas are worth $25 a head; cash is worth $1 to $3. How that balances on a scale is pretty clear. We’ll continue to use formulas and likely do more formula marketing.”
That doesn’t necessarily spell the demise of the cash market. However, Koontz says the beef business will be well-served to go forward thoughtfully as it molds its future. If the trend is toward fewer and fewer cattle traded on the cash market, the industry will need to identify where along the value chain it will do price discovery, and then develop the infrastructure and the process to accomplish that. Or alternatively, the industry will have to decide that it wants a viable cash market and then be willing to pony up to make that happen.
Either way, the industry will have to do something, be proactive, to make sure that it has the markets and market access it wants, Koontz says.
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