If you believe that turns in price offer the most opportunity for making money, then you will be heartened to know the beef industry is now playing on a new and higher price plane. That means you can count on more market volatility.
“Barring an unprecedented market catastrophe, prices aren't going back to where they were before,” says Ann Barnhardt of Barnhardt Capital Management, Inc., a Colorado-based market analysis and commodity brokerage firm. “The $70s should now be the low-water mark for fed cattle prices, where before it was the high $50s and low $60s.”
Prices can still breech the new price floor but, on an average annual basis, prices won't dip beneath the one established by the previous pricing paradigm.
Barnhardt bases her pronouncement on a simple fact understood by economists and intuitively suspected by the rest of us. That's that the record-breaking cattle prices achieved these past two years, especially in the face of BSE and lost export markets, is more than a blip on the screen.
“Since 1920, we've typically seen a new price paradigm established every 24-26 years,” Barnhardt explains. The most recently completed one began in 1978 and came to a close in 2002. There were three others before it (Table 1 on page 18).
Barnhardt notes that the period during the notorious price freeze, escalating inflation and interest rates of the early 1970s created an exception to the rule in terms of how long that pricing paradigm lasted.
In simple terms, Barnhardt says you know you've arrived at a new price paradigm when the old price records are not just surpassed, but are shattered and sustained.
Consider that in 2002, according to USDA, the average annual fed steer price (basis Omaha, 1,100-1,300 lbs.) was $67.04/cwt., compared to the $84/cwt. or so estimated for 2004. USDA reports the combined feeder and stocker cattle and calf average for 2002 at $83.20/cwt., compared to $109.20 estimated by the end of last year. More specifically, the “Cattle-Fax Long Term Outlook” had feeder steers (basis 750 lbs.) finishing last year at an average of $104/cwt.; feeder calves (basis 500 lbs.) at $124/cwt.
So, the jump in price between paradigms has so far been at least 50% compared to the previous one!
“By virtue of the fact the industry is at a higher price level, we'll see more volatility in terms of absolute dollars,” Barnhardt says.
In other words, while the degree of price swings within this new paradigm may be similar to those in previous ones, a higher floor means you can fall farther, even if you fall down the same number of steps. After all, at $60/cwt., a 10% price swing is $6/cwt.; at $90/cwt. it's $9/cwt.
Barnhardt emphasizes, “Clearly, as we've seen in the past year, we'll continue to see more volatility. It's here to stay despite any shocks in the marketplace due to things like BSE and border closings.”
Besides the added opportunity that comes with more turns in the market, increased volatility means risk management — margin calls, option premiums and the like — will become more expensive, just as the need for risk management increases.
Moreover, volatility will likely be magnified, at least in the short-run, because it will take time for the industry to adjust its collective mindset to playing confidently at this higher level. As Barnhardt points out, “Before, cattle feeders had a good intuitive feel for what they could price feeders at based on where the fed market was. No one yet has a ‘second-nature’ feel for what the feeder-fed cattle spread should be at this higher level.”
While it's nothing that can be used for planning or risk management, if this new price paradigm is similar to previous ones, there should be a secondary push in prices in the next 5-7 years, she says. These pushes are characterized as a subtle secondary move forward in average prices, then settling back at a slightly higher average level, rather than the nitro-powered blast that initially launched prices into the new orbit.
Barnhardt sums up: “I don't think it's unreasonable to think we'll see an average annual fed cattle price with a 9 in front of it within the next five years, especially when you consider we're in this new pricing environment without our export markets.”
Indeed, Cattle-Fax estimates fed cattle prices would currently be about $15/cwt. higher if the U.S. was still exporting beef at pre-BSE levels.
Bottom line, more price risk calls for more attention to risk management in all sectors of the industry.
|Years||Avg. fed cattle price ($/cwt.)|
|Source: Barnhardt Capital Management, Inc.|