The hog-corn price ratio has been a useful measure of pork production profitability for many, many years. As such, it has also been a good predictor of pork production changes.
The critical level has historically been 20. When the ratio goes above 20, production will go above year-earlier levels 75-85 weeks later. Figure 1 shows this relationship over the past 17 years.
Note that I have adjusted the relationship during the 1996-1997 cycle when corn prices went to record levels, thus causing the ratio to be unusually low. Adjusting the time lag back to late 1995 when corn prices broke above year-earlier levels, however, shows that this hog-corn ratio vs. production increase episode was about the same length as the others.
So what do this graph and this relationship tell us about recent happenings in the pork industry?
First, it makes the good times of 2004 and 2005 quite clear. Not only did the ratio hit a record high (at least for the time period covered by this graph), but also it stayed above 25 since May 2004 and above 25 from mid-September 2004 through the week before Christmas 2005. It is hard to beat the combination of strong hog prices and low-priced grain.
Second, it is a very strange, profitable time in that production has been above year-earlier levels for 58 of the 75 weeks in this high-ratio episode. It is my opinion that record exports are the best explanation for this unusual occurrence. You're certainly welcome to your own theory. We've simply never seen either exports or hog-corn ratios like this so we have no way to test the relationship.
Third, it is likely that production will remain above year-earlier levels for some time now. While expansion has been small thus far, productivity growth will keep production up. The next USDA Quarterly Hogs and Pigs Report is due on March 31.
Finally, while the ratio reached its lowest level (21.1) since June 2004 the week of Feb. 2, I think it will rise for much of the remainder of 2006. Corn prices have risen, but they have done so basically in a seasonal manner. The normal seasonal pattern for hogs would say they would increase through June or July.
Risky Business?
What are the risks? Record numbers of cattle on feed, chicken production and corn production, as well as the rise in ethanol production will drive usage higher. Should weather problems arise, corn prices will rise to ration this crop and the next. The Corn Belt is dry at present.
The biggest risk for hog prices is a potential problem with exports. That's not likely, but it would have a very negative impact. An additional risk is imports of Canadian slaughter hogs and pork to claim a duty rebate on imported U.S. corn. Those imports will come in April and May, but the number that will cross the border remains the big question.
One thing is certain: The hog-corn ratio will fall, eventually.
Point of Clarification
In last week's newsletter, I made the following statement: "Beginning in 10 days, you will be able to sell spot-month futures contracts for five months."
The statement was apparently confusing to some readers and I apologize for that. All I meant was that Chicago Mercantile Exchange (CME) Lean Hogs futures contracts were available for each of the next five months, April through August. That is important because the basis is smaller and more predictable in a month that has its own contract. Basis in non-contract months (January, March, September, November) is generally wider and less predictable simply because traders don't care about cash markets or basis until the last two days of a contract's life.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com