Was that the sound of a bubble bursting – or was it just the sound of a leak? Regardless, the price moves of the past two weeks have provided some hope for cost-challenged livestock producers.
By all accounts, the driver of this sell-off is the failure last week of Bear Stearns and the losses being faced by many investment funds in mortgage-backed securities. Some of those same funds also had positions in commodities futures and apparently most of those were long positions. Liquidation of those long positions is, according to the trade, the major driver of the downturn in prices. The fickleness of the Dow Jones Industrial Average this week is evidence of both uncertainty and the extreme measures that are being tried in an attempt to allay it.
In addition to the uncertainty in the broader market, it appears that the news from South America points more and more to good crops. The potential fly in that ointment is wet conditions in many parts of Brazil. The harvest there was delayed by late planting, so it does not appear that the conditions are of much concern, yet. USDA has pegged Brazil’s crop at a record 61 million metric tons (MMT). When combined with Argentina’s projected 47 MMT crop, this will leave the South American supply of 108 MMT, 0.5 MMT larger than last year.
Finally, the drought in Southeastern states has lessened in both area and severity in recent weeks. To see this change, go to the Drought Monitor homepage drought.unl.edu/dm/monitor.html and click on 12-week animation.
Corn, Soybean Futures
Figure 1 shows the break in December Corn futures. The chart is representative of all of the other months. Corn futures dropped 60-70 cents/bu. across the board and broke an up trending support line in the December chart that dates back to the passage of the energy bill back in December. That bill raised the mandate for corn-based ethanol to 15 billion gallons in 2015. Many feel that it is the impetus for the latest run-up in both corn and soybean prices.
Figure 2 shows a similar chart for December soybean meal. It, too, looks like all of the other current meal futures chart. This one shows that the up trending support line dating to December was actually broken on Feb. 29. This week’s sell-off added further credence to the reversal by covering a gap at $307.50 and breaking through support at the bottom of that gap. The next technical objectives for this chart would be the top and bottom of last fall’s trading channel at about $268/ton and $249/ton.
Figure 3 puts these price declines into a feed price perspective. The declines of futures prices this week have knocked $20-25/ton off the cost of corn and soybean meal to make a 16% crude protein diet. Assuming that is representative of all of the feed fed to a finished pig (and I think it is), this would reduce feed costs by $7.50 to $9.40/head. That’s the equivalent of a $3.75 to $4.70/cwt. carcass rally in Lean Hogs Futures.
What’s the Plan?
So, what should you be doing? Remember my past admonition to play defense this year. When an opportunity arises to take a substantial amount off the cost of a finished pig – and $7-9/head appears to me to be substantial – you should take action.
Is now the time to cover your needs in futures? Perhaps. But this week’s break is at least a sign that you and your banker should be ready to pull the trigger on feed needs for this summer and, perhaps, next year. I do not know if prices have fallen as far as they are going to fall, but any sign of a bottom would, to me, be a sign to cover some feed needs. And, if you are wrong, you are still far better off than you would have been just one week ago!
The better strategy may be to buy out of the money call options. The strike price that you can secure for a given premium has declined along with the futures market, so you can put a cost ceiling at a much lower level ($7-9/head) than you could just one week ago. The beauty of calls is that they leave the bottom side open and do not require margin – a feature that might be particularly appealing given the tight liquidity position that many producers face. The devil of calls, of course, is that they are a straight cash outlay and, in the case of deferred contracts, not an insignificant outlay due to the time value of the call option.
Regardless of how the markets have treated you lately, take some time this weekend to enjoy the Easter holiday with family and friends. May I suggest a nice Easter ham to celebrate? Tradition, great flavor and an assist in decreasing cold storage stocks – that’s a nice trifecta, I think.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.