Last spring, Dr. Michael Swanson, chief agricultural economist at Wells Fargo Ag Industries, addressed the National Pork Board’s Swine Management Conference on the topic, “Economic Volatility has Consequences.” The presentation was very informative and creative, shedding new light on a number of macroeconomic topics, as well as agricultural markets.

In his presentation, Swanson used a chart similar to Figure 1 (attached) that simply shows Chicago Mercantile Exchange (CME) Lean Hogs futures prices for each contract month into the future on a series of given dates. In Figure 1, I used last week and 31-day intervals for six months in the past. This provides a picture of the outlook for the hog market in the eyes of the futures market at 31-day intervals since May 20, 2010. The set of lines is instructive regarding the past and current “thinking” of the market regarding hog prices.

Back in May, it was pretty clear that hog prices were going to be good during the summer. That positive outlook remained in place through July and the outlook for the fall months began to improve. On July 21, October futures were trading at just over $75 and December futures were at about $73, over $3 higher than they had been back in May.

As summer progressed, expectations for August hogs were pretty much fulfilled. The national net cash hog price at the expiration of the August contract was $80.68/cwt., carcass. This strength and continued strength into September stoked the optimism of futures traders as contracts for October and December rose by roughly $4/cwt., carcass, from July 21 through Sept. 21. That optimism fueled even larger increases in futures prices for next summer.

Then came the fall cash market crunch – driven primarily by unexpectedly large numbers of heavy hogs since Oct. 1. By late October, the December contract had fallen to nearly $70, down from $77 in late September. The decline had pulled February and April contracts lower as well, but note that the May and June contracts remained relatively constant while the more distant contracts rose as traders expectations of output expansion waned.

That pattern has continued through November as the nearby December contract has struggled to get above $70, while deferred contracts have risen to the upper $80s, with contracts from May through August setting or nearing the contract life highs.

Cash Remains King
One clear lesson here is the reaffirmation that “cash is king.” Expectations were rising in August and September, but hit the cold, hard reality of a falling cash market in October. The unusual depth of that sell-off had to be reflected in both the October and December contracts.

The other lesson is that the market takes into account long-term implications – perhaps not fully, but to a great degree. The USDA September Hogs and Pigs report indicated that the U.S. breeding herd, in fact, was not growing during the summer. Combine that with sharply lower prices and the market has concluded that hog supplies will not increase next summer. Further, it appears to me that the market may be agreeing with my expectation that the current surge in growth rates will continue and the first “marketing hole” we might see will be next summer when higher temperatures slow pigs’ growth down.

The catch in these relationships, of course, is that quarterly average futures prices for 2011 are now anywhere from 4 to 11% higher than the respective cash prices in 2010. Those increases suggest an output decline of 1.5 to 3.5%, year-over-year, in 2011. Weights could indeed be lower given higher feed costs. And, recent sow slaughter levels suggest that some farms may be liquidating rather than face another year of losses.

Still, growing productivity causes me to doubt that we will see output reductions. If that is the case, demand must be substantially higher in order to realize the price levels currently being predicted by the futures markets.

Thankful for Pork
I hope you and yours had a great Thanksgiving and enjoyed some great pork – a meat you can truly be thankful for! We had ham in several forms, as well as roast pork loin and all the trimmings. It was a great plan this year – friends on Thursday, immediate family on Saturday and extended family on Sunday. Three for one! I really must work on arrangements for Friday next year.

Click to view graphs.

Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com