After a big rally during October and some retracement during November, Chicago Mercantile Exchange (CME) Lean Hog futures have shown some signs of life recently with the deferred contract holding very near contract life highs. The average value of CME Lean Hogs futures from December 2006 to December 2008 is just over $68.15/cwt. carcass (or about $51/cwt. live). Those prices are significantly higher than price levels for next year based on the September Hogs and Pigs report data, so we must conclude that the futures markets are factoring in something else.
Whatever your opinion about the value of futures markets to pork producers, I believe they are an accurate gauge of "market" sentiment at any point in time, where the market is very broadly defined to include anyone who is willing to bet actual money on what the price of hogs may be. The key, in my opinion, is that there are no barriers to entry to the futures markets and, thus, they are the perfect melting pot for all views of the market. They tend to incorporate publicly available information very quickly and efficiently, but they also reflect non-public information. Many analysts share this opinion.
One possible explanation for the recent strength of hog prices is that CME Lean Hogs futures are incorporating the higher price of corn into pork output. I think they are getting a little too quick in that judgment simply because of the time lag involved in pork production. If I'm correct, then the futures markets may be providing opportunities now that will be better than cash markets next year. Regardless, $68/cwt. carcass and $51/cwt. live are good hog prices even with higher costs!
Adjusting to Higher Feed Costs
The entire meat sector, however, is already showing signs of responding to higher feed costs. Figure 1 shows historical, current and projected levels of my hog feed index (corn and soybean meal to make a 16% crude protein diet) as of Nov. 30. Those projected levels continue to increase and are now very close to reaching the rarified levels of 1995-96. The difference is, they will not go away as quickly as before since this is driven by corn demand, not short corn supply.
About the only encouraging thing I can see in those forecast levels is that the futures markets are now factoring in a corn acreage increase next year. Note the slight dip in prices for late 2007 that were not evident in the previous forecast lines.
The size of the acreage increase will be critical. I have seen forecasts anywhere from 5 to 8.5 million more corn acres next year. Some private discussions set the increase as high as 10 million acres. The livestock sector will need every one of those acres even if yields are very good.
How has this affected the various species? It's difficult to separate out the effect of higher feed costs, but a quick look at Figures 2 through 4 shows that all of the meat species are cutting back. Sow slaughter remains quite high given the level of profits, but gilt slaughter percentages from the University of Missouri have been at or above 50% for the last four weeks. That strengthens the argument that the breeding herd is being reduced and ties that reduction more directly to feed costs.
Beef cow slaughter (Figure 3) has been high relative to last year since June when forage conditions in the southern plains began to deteriorate badly. The recent spike in numbers is really not unusual from a seasonal standpoint, but the real test may be in the remainder of this year. Will beef cow slaughter drop seasonally or stay high due to calf prices as much as $30/cwt. lower and yearling prices $15 to $20/cwt. lower?
Finally, broiler egg sets have been declining relative to last year for some time, due to very low chicken prices. Some private sources are now saying that higher feed prices will keep those reductions in place longer. That's certainly good news for the pork industry.
The quickest response that anyone can make to higher feed prices is an adjustment of slaughter weights and those are moderating in all three species. Hog weights have been 1-2 lb. under year-ago levels in five of the last seven weeks, and even with year-ago in the other two weeks. Broiler weights have been over 3% lower than below year-ago levels for the last three weeks. Steer and heifer weights have not gone below 2005 levels, but they have gone from 15 lb. or so higher in August to only 6 lb. higher for the week of Nov. 11.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.