Market Preview
History Hints at Market Opportunity
I've used an admonition from President Harry Truman before - and I'll likely use it again - "Study your history!"

It appears that such a time is upon us again as we look at the hog market and the prices being offered by Lean Hogs futures contracts. Figure 1 shows historical weekly prices on the nearby Lean Hogs futures contract back to when Lean Hogs futures were introduced in 1997.

February Lean Hogs futures closed Thursday at $65.175. The remainder of the 2007 contracts, except for December, closed above that level, and the contracts for May through July were all above $73.80 (a live weight equivalent of over $55). They are in the range marked by the red circle in Figure 1. By historical standards, those are very good hog prices. In fact, they are among the top 10% of the prices offered in history.

This week's market action has added a bit of fuel to the "price-some-hogs-now" fire. Figure 2 shows prices for July Lean Hogs since the contract came on the board in June 2006. This chart looks much the same as those for May, June and August with the recent price rally well into the $70 range.

All of these charts indicate that the price rally has run out of gas - at least for the short run. In this July chart, you can clearly see that prices broke below a short-run trend line (the blue line) on Tuesday of this week. July futures prices broke below 5-, 10- and 15-day moving averages this week as well.

Has the Market Turned?
Trend lines and moving averages generally measure the momentum of a market. When the actual price moves below these momentum measures, the message is that the momentum has waned and the market is about to turn or, perhaps, has already turned. Think of it as an airplane in a steep climb - at some point it loses airspeed and has to start down.

Does this mean prices of these contracts have topped? Not necessarily. In fact, there is substantial historical evidence that June Lean Hogs futures peak first in early March and then again in early- to mid-May. Those same data show that the July and August contracts usually peak in early- to mid-May. We still don't have enough historical data for the May contract to draw any conclusions about seasonality.

What does this mean?

The prices being offered today are good ones. They are profitable even with high feed costs and, given the magnitude of the feed cost increase, that is pretty remarkable. This suggests that pricing some hogs is prudent. The principle of diversification, though, suggests that some hogs be left unpriced just in case these long-term historical seasonal patterns hold again this year. Be watching for pricing opportunities in late April and early May for those animals.

The Chicago Mercantile Exchange (CME) offers a very comprehensive review of historical futures prices free of charge. The CME's Moore Research Reports for hogs, cattle, dairy products and lumber can be downloaded at www.cme.com/trading/prd/ag/res/moore3356.html. If you prefer a printed or CD copy, call 800-331-3332 or send an e-mail request to: info@cme.com.

Morrell Plant Second Shift Suspended
Yesterday's announcement by Smithfield Foods that it was suspending the second shift and laying off 485 workers at its John Morrell plant in Sioux City, IA, effective Feb. 19 is a bit foreboding. The company cited "unfavorable market conditions" as the reason for its decision.

It is easy to jump to the conclusion that margins must be bad, but the data indicate otherwise. Figure 3 shows my estimates of hog slaughterers' gross margins (i.e. value of the meat and by-products less the value of the hogs). While margins have fallen in the past two weeks, these appear about "normal" for this time of year. What can be said, however, is that pork packers' margins do not usually get much better until the normal seasonal upturn in slaughter occurs in late September. Given that historical perspective and the level of summer Lean Hogs futures prices, it makes some sense to cut back now rather than later -- especially if you think you are going to make that cut sometime this year anyway.

A last interesting point on this subject is the relationship between the labor force reduction and the remaining labor force. Morrell will reduce its slaughter by about 7,000 head/day by cutting 485 employees. It will continue to slaughter 7,000 head/day, but will employ 900 people to get that done. That speaks volumes about the economics of double-shifted plants, doesn't it?




Click to view graphs.

Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com