Is it demand or is it supply? That is the big question regarding the continued rally of cutout values and hog prices over recent weeks. Regardless of the driver, the resounding consensus from producers is: “We’ll take it!” In recent weeks, there have been some hogs – primarily purchased as feeder pigs – sold at a profit. It’s about time.

Figure 1 shows weekly data for national negotiated weighted average (WA) net prices and the fourth quarter rally is quite obvious. There have been Q4 rallies before, most notably in 2004, when cash prices bumped $80 in early December. But that rally died a sudden death with prices dropping to the low $60s by year’s end.

This one, on the other hand, gained strength in December and last week drove prices to $65.28/cwt. carcass, the highest level since Oct. 9, 2008. Now, negotiated prices are the most volatile of the prices reported by USDA and they represent a smaller and smaller percentage of total supplies (more on that next week). But the national WA net price for all purchase methods (Figure 2) has shown the same kind of strength, especially in the first two weeks of the New Year. The only reason the rally of the total WA price was not as dramatic as the rally for negotiated WA prices is that the total price did not get nearly as low as the negotiated price last summer – a fact owing to relatively high prices paid for hog that were priced off of feed or cost matrixes of Chicago Mercantile Exchange (CME) Lean Hogs futures.

Pork Demand Drivers
A case can be made for the demand side of the argument as pork wholesale cuts and the cutout value are unusually strong for post-Christmas weeks. The cutout gained $1.56/cwt. last week on the strength of higher spareribs (up over $20/cwt. since the end of November), wholesale hams that gained over $7 last week and a strong bellies market that carried the composite primal belly value to $80.76/cwt. last week, its highest level since July. Anecdotal evidence suggests that exports are good and the recent drop in the U.S. dollar, which really just ended a slight rally since late November, should help them in weeks to come if the trend remains downward.

But the wholesale prices and hog values could well be driven by supply issues. The brutal winter weather has played havoc with delivery and operations schedules at packers. Last week’s 2.081 million head was nearly 13% lower than one year ago, a far cry from the 2% or so decline expected, based on the December Hogs and Pigs report. Add in carcass weights that were 3 lb. (1.5%) lighter than last year and we get a huge reduction in weekly pork production of 14.5%. While demand may be good, lower supplies are, in my opinion, the major driver of this short-run, post-holiday rally. Again – we’ll take it!

Feed Quality Concerns
The next few weeks will be interesting. First, will slaughter rates increase again to reflect the shipping and slaughter operation disruptions? I think that is likely, but I also think the rebound might be muted by factor No. 2, which is growth rates. This was a major topic of discussion at three producer meetings I attended last week. The concern does not revolve around weather, though, since the vast majority of hogs are in environments that shield them almost completely from these adverse weather events. The concern revolves around corn quality and the high price of fat, which have both resulted in diets that are quite likely lower than normal in energy content.

Producers in the eastern Cornbelt are much more concerned about corn quality since their crop faced so many challenges this year and a good portion of their crop is unfit for hogs due to high mold and toxin content. Concerns were lower in other areas, but low test weights and damaged kernels have some people claiming that their pigs are growing at a noticeably slower pace.

If we get back to some normalcy in terms of weather and scheduling, I think the key variable to watch will be market weights. I doubt that the 3-lb. year-on-year decline will continue, but I do expect this year’s weights to be lower. That could be a powerful factor come summertime when we will be comparing to the “small horses” of 2009.

Keep an Eye on the Rally
Finally, a lean hogs futures market that has looked very “toppy” since late November broke out of a downward sloping trading channel last week with 2010 contracts through October gaining $0.60 (May) to $2.20 (June). December 2010 was down $0.05 for the week. Depending on your risk-carrying ability at this time, I would still be looking to price 2010 market hogs, but I would wait to see what this recent rally will do.

If February prices can break through recent resistance at $68.17, it could move to resistance dating to last spring in the $71 area. All that’s left for summer contracts from a technical standpoint is contract life highs set in the late winter and spring of 2009. But letting the market tell us once again that it is topping looks like a good plan to me – and it will likely happen at price levels that may be profitable for virtually every month of 2010.

After this long dry spell, that really sounds good, does it not?

Click to view graphs.

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