Source: John D. Anderson, Senior Economist, American Farm Bureau Federation
In last week’s ICM newsletter, John Michael Riley summarized the monthly World Agricultural Supply and Demand Estimates (WASDE) report from USDA. Obviously, the highlight of that report was the deteriorating prospects for this year’s corn crop. The market has, of course, been monitoring crop prospects and updating expectations continuously all season long and has continued to do so since last week’s report. The judgment of the market can be quickly assessed by looking at prices. Corn prices have posted an impressive run over the past month. In mid-June, the December 2012 corn futures contract on the CME was trading at around $5.20 per bushel. As of this writing (at mid-day on July 16) Dec 12 corn is trading at about $7.65, a 47% increase.
A corn price increase of the magnitude that we have seen over the last month has major implications for related markets including, naturally, livestock markets. The broad strokes of the adjustments that take place in the livestock and poultry sector are easy to understand: higher corn prices drive up feed costs and higher feed costs result in lower production of livestock related products (beef, pork, chicken, dairy products, eggs, etc.). As a practical matter, though, adjustments to higher corn prices involve the rebalancing of very complex production systems. This process takes time, and it can be quite painful for those involved in it. So, at this early point – still only about a month into this situation – what adjustments are we seeing?
We can start with something easy: feeder cattle prices. When corn prices go up, feeder and stocker calf prices go down (ceteris paribus, of course, as we economists like to say). As increasing corn prices raise feeding costs, buyers attempt to protect feeding margins by paying less for calves to feed. An old rule of thumb is that as corn prices go up by $1/bushel, feeder cattle prices will go down by $7 or $8 per hundredweight. This year’s experience is not too far out of line with that. The nearby Feeder Cattle contract on the CME is currently trading around $136 – a decline of about $24/cwt since mid-June. That’s a drop of almost $9.80 to $1 based on the corn price increase mentioned earlier. That’s worse than the simple rule-of-thumb would imply but it’s important to note that higher corn prices are not operating in a vacuum. Lower feeder calf prices also probably reflect some supply-side pressure in the market from drought-induced selling and some additional demand weakness from a lack of alternative places to go with calves because of a lack of forage.
High corn prices should also affect the relationship between the prices of calves at different weights. Typically, the cost of adding weight to a calf is less than the value of that additional weight. This potential return to adding weight is bid into the per unit price of calves. This results in the familiar condition wherein the price per hundredweight is higher on lighter calves than on heavier calves. As corn prices rise, the cost of putting weight on calves rises as well. While not all calves will be grown or finished on corn-based diets, as corn prices rise, the value of any alternative means of growing or finishing calves (including pasture) goes up as well. As a consequence, the spread (or slide) between per unit prices of calves at different weights narrows. In some circumstances, the slide may actually invert – that is, per unit prices will be higher on heavier calves than on lighter calves. We are not yet at that point, but the price/weight structure in calf markets has flattened. Since mid-June, the price on 400-450 pound calves in Oklahoma (as reported in the National Feeder and Stocker Cattle Summary from USDA-AMS) has declined by almost 15%. At the other end of the weight spectrum, the price on 900-950 pound calves has declined by just a bit over 5% during that time. Looking at it another way, in mid-June, the average price of a 575-pound steer was a little more than $18 higher than the average price of an 825-pound steer. Last week, that spread was down to about $7.50.
As mentioned above, when corn prices go up, the prices on alternative feeds goes up as well. This has been evident in the recent corn price surge. According to the weekly USDA-AMS feed price reports, pretty much anything that can be used for feed, from soybean hulls to hominy to wheat midds to rice bran, has increased substantially in value over the course of the summer. Dried Distiller’s Grains (DDG) prices have been particularly interesting. Higher corn prices have not only increased the value of DDGs as a substitute for corn, but the resulting pressure on ethanol producer margins has slowed down production. This relative tightening of the distiller’s grain market is evident in comparisons with year-ago prices. Last week, averaging USDA data from across the Corn Belt, DDG prices were about 97% of the price of corn (on an as-fed basis). Last July, when ethanol production was considerably higher, DDG prices were less than 80% of the price of corn.
Almost without question, the recent major run-up in feed costs, along with broader concerns about feed availability due to drought, are having major fundamental effects in addition to those outlined here. There is no shortage of anecdotes about early weaning of calves, herd dispersals, and other forced adjustments to the current situation. Similar anecdotes apply for the hog, broiler, dairy, and egg sectors as well. Hard data to back up those anecdotes – data like feedlot placements, cow slaughter, hog slaughter, chick placements – is very preliminary at this stage in the process, but such data will begin to come into much clearer focus soon. For now, price relationships in the livestock and feed markets are already telling an interesting story.
Calf prices were down last week. Consistent with the discussion in the preceding section, the biggest hit was on the light end of the weight scale. Here is the headline from last week’s OKC summary:
Compared to last test 2 weeks ago: Feeder steers and heifers 2.00-6.00 lower, least decline on heavier weight, short term cattle. Six weight cattle up to 10.00 lower. Steer and heifer calves 10.00-20.00 lower.
Fed cattle prices slipped a bit more as well. The weekly 5-area weighted average price came in at $114.65 last week, down $2.46 from the prior week. Negotiated volume was the largest in over a month but still looks a bit light as feeders seem understandably reluctant to take their licks. Wholesale meat prices aren’t helping out much. The Choice cutout averaged $187.33 last week, over $6 below the prior week’s average. The Select cutout held up better: dropping $2.57 from the prior week.