There has been a lot of doomsday talk about the pork industry this week. I certainly can't argue against the idea that 2008 will be a very tough year for U.S. pork producers and, as I have pointed out before, even worse for Canadian producers. But, there are some reasons to be careful before you buy into "the sky is falling" predictions.
First, the bad news. Slaughter last week was 2.1% larger than was predicted by the December Hogs and Pigs Report (see Figure 1). The good news, though, is that percentage difference is the smallest since Sept. 29, with the exception of Christmas week. Daily estimates for this week through Thursday were up 5.6% from 2007. That number is actually smaller than the 6.1% increase expected, based on the December report. Although this is written before week's end, getting near the report-implied slaughter level is encouraging.
Now, for worse news. There doesn't appear to be much respite in the grain markets. Corn closed a bit lower Thursday, but most of the contracts traded at contract life highs sometime during trading on Wednesday. Nearby soybean meal contracts also closed lower, but those closes came off of contract life highs on Tuesday and the deferred meal contracts hit contract life highs on Thursday. Wheat, after a mini-rally last week, has fallen again, but don't expect lower wheat to exert any direct pressure on corn. Corn price is simply too high for wheat to be viewed as a competitor in the feed market. And, the fact remains, wheat and corn are generally grown in different places in the world so the battle for acres between the two crops is limited. The southern Corn Belt of the U.S. may be the most notable place where they are, in fact, competitors for acres. But that battle has already been fought since winter wheat was planted last fall.
These increases in cash and futures prices for corn and soybeans have now driven my forecast feed price index to record highs (see Figure 2). The increase in feed costs since the summer of 2006 have added over $30 to the cost of raising a pig. Current prices and costs are not fully in the market yet, since the pigs being sold today ate some lower-priced feed a few months ago.
While hog prices will not be good this year, the cost situation is a far bigger threat to producer profits. At this point, there is not much that can be done. USDA lowered its projected 2008 carryout corn stocks by 359 million bushels in this morning's World Agriculture Supply and Demand Estimates (WASDE) report. That reduction was the result of a reduction in the 2007 average corn yield (from 153 bu./acre to 151.1 bu./acre -- still the second highest ever) and a 300-million bushel increase in forecast feed and residual usage. The report also increased its estimate of season-average farm price to $3.70-$4.30, adding 35 cents on both ends. That estimate, though, is still lower than the farm price implied by current futures values.
USDA decreased projected carryout stocks of soybeans by 10 million bushels. The reduction was caused by a 9-million bushel decrease in 2007 production due to a 0.1 bu./acre reduction in yield. Projected ending stocks of 175 million bushels are the third lowest on record and drive the projected ratio of year-end stocks of total usage to a squeaky tight 5.9%. The result is another big change for the soybean price forecast -- raised 65 cents/bu. on both ends of the range to $9.90-$10.90. Those numbers have both increased by $1.40/bu. over the past two months. Estimated meal prices were increased $40/ton to $305-$335. Those numbers are $70/ton higher than two months ago.
The important factor for these forecasts is that they are still all below current futures prices. Yes, USDA is sort of chasing these markets and the USDA forecasts are for farm-level prices for the grains, so basis levels are a key factor. But they also underscore the risk premiums that are in these futures markets.
I won't argue that the risk premiums should not be there or, for that matter, that they are too large. There is substantial risk in these markets, but one must remember that a few developments can take the risk premium out quickly. Look at the feed cost index graph for 2004, and even last summer, when it went from $155/ton on June 15 to $121/ton on July 27. Could that happen again? Absolutely. It will not take the feed cost index to $100, but it could easily take it back to $140 or $150. That would be a very nice development.
Price Trend Not Unusual
Soft cash hog prices have also increased the level of hand wringing in that market, but we must remember our history. It is not at all unusual for cash hog prices to remain weak into January. Hog runs are still large and the holiday feasts are over. That cash weakness drags down the entire futures complex.
Historical data from the Moore Research Reports (available free from the Chicago Mercantile Exchange (CME) at www.cme.com/trading/prd/ag/moore.html) indicate that December and January are about the worst time to be selling summer hog futures. The seasonal charts for June and July Lean Hogs are shown in Figure 3. Both show a strong historical pattern of prices increasing from early January through early May -- and CME Lean Hog futures prices were up sharply in Wednesday's trading. They rose again on Thursday. Whether this marks a reversal of those price trends remains to be seen, but Wednesday was the most positive day we have seen for quite some time and it's the first encouraging news for hog prices in some time.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.