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Tighter Margins In 2005

For the cattle feeder, stocker operator or cow-calf producer, 2005 is forecast as a year with slim profit margins, even with continued low corn prices. But a quicker reopening of foreign markets closed after the 2003 U.S. BSE incident could fuel better-than-expected markets. Analysis by several university and industry economists point to what could be a a more normal year of price volatility unlike

For the cattle feeder, stocker operator or cow-calf producer, 2005 is forecast as a year with slim profit margins, even with continued low corn prices. But a quicker reopening of foreign markets closed after the 2003 U.S. BSE incident could fuel better-than-expected markets.

Analysis by several university and industry economists point to what could be a “a more normal” year of price volatility unlike the roller-coaster markets of 2003 and the first half of '04. Of course, there will always be unexpected spikes, like the $2.70 plunge in the December '04 live cattle futures (in November 2004) on the mere rumor of another BSE outbreak. (When the negative BSE test came back, the market regained most of what it had lost within six days.)

Overall, feedyard owner-operator Walt Olson of Turpin, OK, sees a trend for profits in the $20 to $30/head range at best. But like cattle market gurus, he feels all bets are off if another BSE case emerges.

“We hedge a lot of our company cattle. With breakevens in the mid-$80/cwt. level for early 2005, we saw the need to protect prices we can lock in at $88 or $89,” says Olson, who runs Tri-State Feeders, Inc. in the Oklahoma Panhandle.

Olson sold $89 February live cattle futures to hedge cattle slated for the packer that month. The move was made in October. However, with the wet weather that hit his region in late fall, there was potential for a rougher than normal winter that could cause prices to increase.

To protect his hedges, Olson bought $94 February call options, spending about $1.05 for the calls. In general, it was an insurance policy that cost about a buck.

“If the market takes off due to the weather or for another reason, we can prevent losses to our futures positions,” he says. “If the market is below $89, our hedges will keep us protected at that level.”

Dillon Feuz, University of Nebraska livestock marketing specialist in Scottsbluff, says marketing strategies for fed cattle in the spring and summer should aim first at protecting the breakeven.

“Feeders need to look for opportunities to put protection in place through futures or options,” he says. “For example, they should look at April futures in the $84 to $86 level, or June at $82 to $83.”

If using options, Feuz recommends producers consider buying a put, then selling a call to lower the price of protection. If straight futures are used, then look at hedging a percentage of the cattle. Then, if prices increase, look at hedging additional cattle at the higher price, he says.

Fed cattle projections

If projections by analysts are accurate, Olson's hedges in the mid to upper $80s should be on line. John Lawrence, Iowa State University livestock marketing specialist, believes this year's first-quarter fed-cattle prices will be in the $84-$88 range. He sees second-quarter prices at $86-$90, third quarter at $83-$87, and fourth quarter at $85-$89.

“There are positives and negatives for the 2005 outlook,” Lawrence says. “The positives are the possibility of Japan and other Pacific Rim trade (for U.S. beef) starting back in the second quarter, higher pork prices and the continued popularity of low-carb diets. The weaknesses are the likelihood of heavy carcasses, more cattle on feed and Canadian cattle available to the U.S.”

Jim Gill, Texas Cattle Feeders Association market director in Amarillo, says it's difficult to make on-target projections in today's cattle environment. Further complicating that task is the wet weather that led into winter.

“I think fed-cattle prices have settled into the $80 to $90 range for the foreseeable future,” Gill says. “This doesn't exclude forays below $80, or above $90, for short periods of time, especially in the case of a weather market like we may be building. Given the last two months' (fall) weather patterns, I would think prices in the first quarter could be between $85 and $95.”

Feeder cattle forecasts

Feuz sees more downside potential for fed cattle than feeders, but feeder cattle still need risk protection.

“Stocker cattle should have a good spring if there's sufficient moisture for grazing,” he says. “There will be a good demand for feeders. But producers should consider buying ‘cheap put’ protection against things like BSE or if the market is soft.”

He suggests looking at out-of-the-money May feeder cattle puts in the $95-$97 level, or about $2 below the actual futures price. A $2 out-of-the-money put option should be available for a cost of $2-$4/cwt.

Gill and others see feeder cattle numbers remaining tight, a situation that created a $30 spread between feeder and fed cattle prices in the fall.

“However, I feel they were overdone on the upside and I expect to see adjustment, especially since some fed cattle are losing money,” Gill says. “We saw an $8 to $10 adjustment to heavy weight (700-800 lbs.) feeder cattle in the fall. If the loss situation continues in the feeding industry, another adjustment of that magnitude would not surprise me. I see first-quarter feeder cattle prices in the $98 to $105 range.”

Lawrence also sees a continuation of tighter feeder cattle supplies along with heifer retention. Those, plus a bin-busting corn crop of 11 billion bu., may not be enough to hold feeders at the $100 level.

“Also, feedlots lost money most of the fall and will likely continue to do so into the dead of winter,” Lawrence adds.

For 700- to 800-lb. steers, he forecasts first-quarter prices in the range of $97-$102. Second-quarter prices are pegged at $92-$97, third quarter $98-$103, and fourth quarter $94-$99.

Derrell Peel, Oklahoma State University livestock marketing specialist, says, “sooner or later, the $30 spread must narrow and it means either fed prices must increase or feeder prices will decrease. The timing is a bit uncertain, but it could mean decreased feeder cattle prices in the first quarter.”

Calf prices

Peel says if feeder prices adjust down, stocker producers could be hurt due to strong calf prices seen last summer and fall.

“If enough pressure develops and lasts long enough, it could eventually push calf prices down as well,” he says. “But this will occur only under very severe and prolonged fed and feeder cattle market problems.

“By the time we work through the winter and see how the fed and feeder markets play out, calf markets will be looking ahead to green grass and will likely stay strong.”

Lawrence sees prices of 500- to 600-lb. steers in the $112-$117 range in the first quarter, $115-$120 in the second, $113-$118 in the third, and $99-$105 in the fourth.

“Tighter domestic feeder supplies, the beginning of heifer retention and the large corn crop are positives for calf prices,” he says. “The weaknesses, as in with feeder prices, will be feedlots losing money most of the winter and the influx of Canadian cattle into the U.S.”

Gill looks for 300- to 400-lb. calves to drop from fall's $150-$165 range to $130-$140 early this year, “but who knows for sure,” he adds. He believes the Canadian reopening will pressure feeder and calf prices, “but I don't think there will be that many fed cattle to come across.”

Exports to help

Undoubtedly, prices will be helped by reopening foreign markets like Japan. Alan Smith, chairman of the U.S. Meat Export Federation, notes the BSE-induced loss of exports cost producers and feeders $13-$15/cwt. or $165-$190/head in 2004. But with the many factors that can impact cattle prices, he says accurate predictions on how much of those losses will be made up in 2005 and beyond are difficult.

Lawrence sees both Japan and Canada reopening at about the same time.

“I think initially cattle prices will decline on access to the larger supply of Canadian cattle before demand for beef to Japan will offset it,” he says. “It may be that Japanese buying could surge for the initial order but lull while the Japanese decide if their consumers will buy the product.”

Gill sees a partial rebound, but isn't as positive as some about a big price bounce.

“Opening of the Japanese market will help exports, of course, but I think people are building too much into the Japan reopening,” he says. “We will have to work to get back the market Australia and New Zealand captured. It won't be easy.”

And, he adds, if it's next summer before Canada is allowed to sell cattle into the U.S., Canadians will be close to handling all their own harvest needs. That means beef will cross the border rather than live cattle.

“This additional harvest capacity in Canada may have long-term impacts on our export markets,” Gill says. “I think Canada may take some of our export market, especially Japan. I don't think R-CALF has thought through the ramifications of suing USDA to keep Canada closed.”

Lawrence believes stocker operators and backgrounders are facing significant price risk this year.

“Futures and options can help prevent large losses, but probably won't cover full cost,” he says. “The feeder cattle insurance products are worth looking into. They have several classes of cattle (heavy and light, steers and heifers, Holsteins and Brahman). The insurance behaves like buying a put option, but has a small subsidy.”

Lawrence says the use of futures and options in today's markets can cover catastrophic losses, but can be difficult in covering breakevens.

“The new livestock insurance products can also offer protection,” he says. “Buying corn at harvest lows and paying interest makes sense given the carry in the market.”

Olson, for instance, often protects his corn costs with futures or options. He plans on doing the same for 2005.

“We buy corn calls that cost us about 2¢/bu.,” he says. “We buy enough corn calls to cover (corn fed to) the number of cattle to close out in a given month. It adds to the cost of corn initially, but if corn prices increase due to weather or other problems, we can capture some of that upside gain to offset the increase in the cash price.”

Larry Stalcup is a freelance ag writer based in Amarillo, TX.

Predictions 2005

Fed cattle
1st qtr 2nd qtr 3rd qtr 4th qtr
Lawrence $84-88 $86-90 $83-87 $85-89
Gill $85-95
700-800-lb. steers
1st qtr 2nd qtr 3rd qtr 4th qtr
Lawrence $97-102 $92-97 $98-103 $94-99
Gill $98-105
500-600-lb. steers
1st qtr 2nd qtr 3rd qtr 4th qtr
Lawrence $112-117 $115-120 $113-118 $99-105
300-400-lb. calves
1st qtr 2nd qtr 3rd qtr 4th qtr
Gill $130-140