Chicago Mercantile Exchange (CME) Lean Hogs futures appear to be confirming a cycle low, especially given the performance of deferred contracts over the past few weeks. Figure 1 shows the weekly chart back to 1990. While the latest observations on that chart (February contract) are nothing to write home about, the remainder of the contracts for this year have risen steadily and now represent decent hog prices, even considering high feed costs.
Figure 2 shows CME Lean Hogs futures prices as of Friday morning. Put those on the weekly continuation graph and you can see that they are indeed in rarified air. Thursday's close of $82 for the February 2009 contract is within shooting distance of the all-time high Lean Hogs price of $86.60 for the June contract set back in April 1997. The 1990 high in Figure 1, though, represents a live hog price of $67.45, which would be just over $89 on a carcass weight basis. Although not record high, the air is certainly thin at these heights.
Amid all the talk of sow liquidation, I have to pose this question: Given these futures prices, where is the incentive for any big cutback in the United States? While costs are astronomical by historic standards, these futures prices allow a breakeven (or better) year in 2008 and, based on the value of the February contract, hold the promise of good revenues going forward. How much it may cost to feed the pigs to be sold in 2008 remains to be seen, but the revenue side looks pretty good.
Remember a few weeks ago when cash hog prices were falling like a rock and an unexpectedly large slaughter of 2.434 million left us scratching our heads? The prevailing mood in the business was that things were going south fast and there was little that could be done. From that week through last week, cash hog prices climbed over $2.50/cwt., carcass, and Lean Hogs futures have been on fire with summer contracts gaining $7 to $8/cwt., December gaining nearly $10, and February 2009 gaining $12. Conventional wisdom is seldom correct in times of extreme duress!
Kevin Grier of Canada's George Morris Centre raised an interesting scenario at the recent Banff Pork Seminar. He posed the question: "Could Canada soon become a net importer of pork from the United States?" Given the history of trade between the two countries, and the huge difference in population (roughly 300 million vs. 33 million), the question seemed almost preposterous -- until he showed a graph similar to Figure 4.
Should the trends of the last six months of 2007 continue, Grier's premise is more than just a possibility. The driving factor, of course, is the relative value of the countries' currencies. A stronger Canadian dollar makes Canadian pork more expensive for U.S. buyers and U.S. pork less expensive for Canadian buyers. In addition, the higher Canadian dollar makes the production costs that are geographically fixed in Canada (infrastructure, plants, labor to a great degree) higher, thus making Canadian products, in general, and pork in particular, more costly.
The discussion generated at least one accusation that this shift in relative traded volumes is the result of U.S. companies dumping product into the Canadian market. I disagree, and I would argue that the exchange rate is a much better explanation. Still, the accusation got me thinking about the entire idea of dumping.
Dumping is defined as selling a product in another (usually foreign) market at a price that is below the cost of production. The relevant question is: "Whose cost of production?" The ability of country "A" to produce and sell a product into country "B", below country B's cost of production, is the essence of competitive advantage and international trade. But if country A is selling the product in country B for less than country A's cost of production, it is, technically, dumping.
The problem with that definition is easy to spot: In a commodity business with price cycles, we all have to sell below the cost of production from time to time. It's not a choice. It's just the nature of the beast, and making a dumping case out of cyclical variation is not a good use of anyone's time or resources.
This entire scenario is made even more difficult when the items you sell are parts of a whole instead of entities unto themselves. If a company is selling wheel bearings, the cost of those bearings can be determined with relative accuracy since each one is made from a specific amount of steel put through machine processes at a specific speed and packaged and transported in a manner from which the per-item cost can be easily derived. There is no huge cost allocation problem.
Determining the "cost" of one part of a pig carcass, on the other hand, is a bit trickier. We know what the total cost of the carcass is, but does that mean the cost of each piece of that carcass is the same? Maybe so, if the cost is computed precisely at the processing point where the cut comes off the carcass. Beyond that point, though, some pieces require more labor and plant resources than others and, thus, must have different costs.
These computations are further complicated by the fact that different cuts have different values in the marketplace, thus allowing them to carry different shares of the total cost. For example, why can packers sell trimmings at $0.50/lb. when the hanging carcass costs them $1.00/lb.? Because tenderloins sell for $3.00/lb. and ribs sell for $4.00/lb. So, is selling trimmings at $0.50/lb. -- an amount clearly below the average cost of the carcass -- dumping?
This is a complex issue. I would propose it is so much so that we are far better off focusing our time and effort on constructing information systems and, if needed, regulatory processes to make sure that well-informed, competitive markets are at work. Their power to handle such matters is immense -- if we will let them do so.
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Steve R. Meyer, Ph.D.
Paragon Economics, Inc.