If there is anything more remarkable than the weekly slaughter runs we have seen thus far in October (in case you missed it, we set another record last week at 2.353 million head), it has been the fact that cash hog prices have held their own. If you had told me (or anyone else for that matter) last summer that we would see this level of slaughter in October, I would have told you I was concerned, but that slaughter wouldn't get that big, especially that early. If you had told me that slaughter would indeed get this big this early, and that negotiated net hog prices would still be nearly $58, I would have inquired about your inhaling habits!
Figure 1 shows negotiated net prices on a weekly basis. The decline in hog prices two weeks ago was definitely no fun for those selling on that pricing method. But slaughtering 2.321 million head two weeks ago and 2.353 million head last week hasn't triggered an unmitigated disaster. Further, Thursday's price was higher than last week's average, and this week's estimated federally inspected (FI) slaughter is 5,000 head more than last week's pace through Thursday.
The cutout value has fallen as well but it remains above $60/cwt. Again, this is not a bad showing for these kinds of supply levels. Hams are still the only cut that is under heavy pricing pressure. Think of where we would be had ham shipments to Mexico during the summer just matched those of 2006.
None of this means that I'm not concerned and I'm skipping along singing, "Don't Worry, Be Happy" to pork producers. This fall could still be very tough on the bottom line, cash reserves and/or operating loan balances. On average, FI hog slaughter levels out for the remainder of October and into November before spiking about 5% in early December to handle the hogs not slaughtered during the Thanksgiving holiday.
It will be very difficult to push 5% (about 100,000 head) more through U.S. packing plants given the fact that last Saturday's run was 243,000 head. But U.S. packers processed 300,000-plus on a Saturday in 2003 and 2005 and almost did it last year. Oh yes -- and it happened twice in 1998. Ugh.
Pork Demand Holds Prices Together
Why have things held together? Demand. Domestic pork demand is 1.9% higher than last year through August, and export value is higher even though export quantity is still slightly lower than last year (see last week's North American Preview for details). Whether those numbers are going to be large enough to soak up continued high production remains to be seen, but they have done well so far. One packer told me last Friday that they were remarkably "clean" (meaning they had most of the week's production sold) going into the weekend considering the number of hogs they had handled the past two weeks. I hope that trend continues.
Cashing in on Futures Prices
Producers should note that the quotes for negotiated prices, whether on the daily purchase reports or the prior day slaughter reports, will not be a perfect barometer of producer revenues and profits this year. The prices of hogs sold on Other Market Formulas (virtually all cash delivery contracts tied to futures market prices) are running as much as $10/cwt. carcass above the negotiated price. It certainly appears that a number of you did indeed price hogs during last summer's futures rally. Good for you!
And there are many, many more hogs that have been hedged by producers instead of contracted through packers. Those premium prices will not show up in a price report, since the producer will simply sell the hogs at the negotiated or some formula-based price, and then capture the extra profit from the future market when they lift hedges this fall. Good for you, too!
Futures May Provide Profits in '08
Which brings us to the futures market now and what it means relative to fundamental supply and demand. Figure 2 shows a summary of price forecasts by four analysts or analysis groups based on the September Hogs and Pigs Report. Note that all of us actually forecast a different price series, but you can use the annual averages for 2006 to see the "normal" differences that exist in these prices.
Regardless of differences, one thing is clear: none of us believe that current fundamental supply and demand will result in hog prices anywhere near what Chicago Mercantile Exchange Lean Hogs Futures are offering for next year. That doesn't mean the futures are wrong. I don't like to bet against many, many people using real money. But the fact is that futures prices are offering positive margins for much of next year if you have costs in the high $40s on a live weight basis or mid $60s on a carcass weight basis. Perhaps more important, they are offering only small losses in Q1 and Q4 of 2008 and those quarters appear quite problematic at present.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com