If it’s action you like the past several weeks have recharged your batteries.Following an extended $96-7 run the market found itself at a critical juncture in mid-May.Sellers were forced to make an important strategic decision:hold out for higher money using surging wholesale prices as leverage or accelerate sales in the face of CME’s steep June discount.The decision was in favor of the former setting into motion a bargaining standoff which lasted all week; trade developed only after Friday’s (May 18) CME close. Both sides claimed victory – feedyards upped the ante ($98-98.50) while packers managed to protect a big chunk of available margin.
That victory for cattle feeders was seemingly short-lived, though.The following week (ending May 25) cattle traded mostly $3-4 lower with sales at $94-5. And post-Memorial Day business resulted in another bite out of the market with sales mostly $92-3. Meanwhile, June began on a softer note with trade being facilitated at $91-91.50. All said, since the mid-
May rally the fed market has regressed $7 (or $90/head) in just 3 weeks.
Spring highs are definitively behind us and market participants are now fully in the throes of summer fundamentals. The inherent question revolves around depth and duration of summer lows. From a broad historical perspective (10-year average) expectations would outline approximately a 15% decline from spring highs to summer lows; given a $100 benchmark as the spring high, prices would be expected to bottom around $85.Alternatively, the CME August contract is hovering around $89-90; taking into account the 10-year basis trend provides a similar outlook. However, forecasts and expectations are always a moving target.
Summer is shaping up with some important factors which are evolving and need to be considered with respect to risk management.First, USDA’s cattle-on-feed report indicated a historically large inventory of 120+ day cattle (4.8 million head) exceeding the 5-year average by more than 20%. Second, wholesale values have hit the wall.The Choice cutout fell below $150 on June 8 (the lowest level since early-March): equivalent to a $17 decline from May’s $166 peak several weeks earlier. Perhaps more importantly, the Choice-Select spread has significantly narrowed and finished the week at $7. Concern about the housing slowdown and sluggish consumer spending may possess considerable impact upon the beef complex in coming months.
Conversely, several factors provide friendly support to the market. One, high corn prices possess an upside - they encourage marketings and help to ensure showlists remain relatively current. Two, narrow Choice-Select spreads provide a similar incentive.Three, packer margins have been favorable and certainly aid in keeping sales active. And as mentioned last month, summer months are typically very important with respect to profitability on the processor side and when favorable help in facilitating sizeable throughput. Lastly, beef witnessed an unexpected surge in activity last year during June.
We’re entering a period in which feeder sales are relatively slow and buyers begin to focus on aspects which influence pricing during the fall run. CME’s October Feeder Cattle contract staged a $4+ rally over the past month but has since given those gains back and now appears poised to retest support levels at $108; much of the decline directly attributable to volatility over on the grain side.There’s more of that to come - the corn market will likely provide even more volatility in coming months – it’s a weather market for the next several months. Any concern about the developing crop will serve as a catalyst into positive territory while taking equity out of the feeder market.Cattle feeders will be especially careful about purchasing replacements as summer evolves.Given the amount of uncertainty surrounding the corn market, summer video sales have the potential to be especially dicey.
During the past several months the Monthly Market Profile has highlighted ethanol’s implications upon the beef industry and agriculture in general. It’s an important topic which has received widespread media coverage including several key reports during the past several weeks which may be of interest to readers:
“Ethanol Reshapes the Corn Market” (USDA:ERS)
“The Long-Run Impact of Corn-Based Ethanol on the Grain, Oilseed, and Livestock Sectors:A Preliminary Assessment (Iowa State Univ. Center for Ag and Rural Development).
Ethanol production has dramatically increased the long-term commitment to corn utilization in the United States and thereby shifted demand fundamentals.As such, the implications are pervasive for the industry (not to mention impact upon consumers and rising food prices). Most notable among these:increased rivalry for inputs within the agricultural sector.
That rivalry has proven especially important in the southern feeding region. April’s MMP outlined that Kansas and Texas combine for approximately 877.5 million gallons of annual ethanol production subsequently requiring 337.5 million bushels of corn - equivalent to nearly a 55% increase in feedbunk capacity in the region.There’s been a significant increase in regional demand and an important influence on regional markets. The first illustration represents regional corn prices for the Texas Triangle, basis Omaha.Note that basis has been on an upward trend during the past several years.Considered alone, a twenty cent increase doesn’t seem significant. However, it represents an additional $125 million in annual costs for the Kansas / Texas feeding industry.Alternatively, increased basis signifies an additional $10/head in feeding costs. That’s substantial when considering that most cattle are purchased at-or-above breakeven - it places the region at a purchasing disadvantage especially if the difference results in negative closeouts.
The direct influences of expanding ethanol production are relatively easy to account for.However, I previously noted in the on-line forum that the biggest impact may not stem from the direct effect of higher corn prices but rather the indirect effect of a transitioning farm sector. Agriculture is, by definition, a commodity business – a zero-sum game with long-run returns averaging no better than breakeven.The winners are those who excel at efficiency and possess below-average costs.And within that framework, the expectation is that costs of production will rise to meet higher prices:both variable costs (seed, fertilizer, etc…) and fixed costs (equipment, land, etc…) will incrementally move upwards in response to increased revenue.
Rising fixed costs mandate increasing output to remain profitable; the drive is to spread out higher fixed costs over a larger number of units of production (e.g. acres).Within that environment, larger producers possess an inherent advantage –marginal costs of purchasing new acreage is relatively lower for larger producersAnd the industry is already witnessing higher land values:the Federal Reserve Bank of Chicago reports land values in Illinois, Indiana, Iowa, Michigan and Wisconsin climbed 10% during the 1st-quarter.That’s not unique, though, to farm ground; Kansas City’s Federal Reserve Bank reports increased values for all types of agricultural real estate – nearly twice the 12-year average since the country’s last surge in grain prices (see chart below).Simultaneously, a variety of sources are reporting hypercompetitive bidding leading to rapidly escalating cash rent values.
Within an environment of rising real estate prices it’s likely we’ll witness a wave of consolidation. Land prices and/or lease contracts could quickly become restrictive for cow/calf and/or stocker operators in areas where grass may be tillable.Ultimately, that could not only stall herd expansion but initiate liquidation especially when considering current producer demographics.That scenario possesses some significant connotations for agriculture;fewer operators mean less need for service infrastructure – both public and private.It also means increased pressure on those sectors already facing challenges due to overcapacity – namely feedyards and processors.
References to a future time “when the market gets back to normal” is an unlikely proposition – there’ll be ongoing transformation as more ethanol plants come online – all of which means constant adaptation.This is a critical period for the business environment within all of agriculture.Beef producers, at all levels, need to understand the full ramifications and nuances of the influence. As such, all market participants need to carefully monitor new developments to fully understand the implications and react accordingly to remain profitable.
Stay posted!!!!
