Several months ago a comment from an equity market technician caught my attention. Following his discussion about the current investment environment, the show’s host quipped something to the effect of, “That’s why you’re the expert.” The analyst immediately replied back, “No, the market is the expert, I’m just an observer.” The action of the past month speaks to the principle, for just when you think the market might be out of bullets, it reloads and fires again.
That was the case as March closed business; cash trade reversed from the previous week’s direction and surged $7to close out the month at the unprecedented level of $121-2. And April subsequently opened with positive follow-through; in somewhat haphazard fashion feedyards captured another $1-2 with sales at $123-4 and some trade as high as $125. CME’s deferred live cattle contracts have also ratcheted higher during the past month. For example, the June contract surged from testing $110 in mid-March to almost $121 by April 4 (an ascent nearly equal to $1/cwt per day).
Market prosperity is certainly not a new story. The exceptional strength and persistence surrounding the run, though, continues to be somewhat surprising. Much of the broader coverage relative to the market’s performance seemingly looks to the supply side as explanation. That is, limited availability of cattle has driven buyer competition to fill shackle space. But that focus overlooks the demand side of the price equation – more volume and higher prices.
For example, April’s wholesale beef market opened by underscoring the previous week’s positive action with Choice boxed beef sales crossing $190. Meanwhile, throughput in the first quarter is running nearly 2% ahead of last year’s pace: 2011’s weekly production average stands at 495 million lb versus 2010’s average-to-date of 485 million lb. The market is largely being driven by strong export sales (albeit a portion of that is directly attributable to a weaker dollar – another topic for another day) coupled with resilient domestic demand (more on that later).
All that said, there’s some caution signs beginning to appear and there needs to be careful respect for potential reversal of momentum. While the cash market was working higher during the first week of April, the futures market began retreating. As such, spring highs have likely been locked in for 2011. Opposing forces primarily include concerns about broader consumer challenges on the domestic front. Those stem from pressures like rising fuel prices or worries about the renewed decline in home values. Consumer anxiety regarding the economy and individual position has improved during the past several years but still weighs fairly heavily on most individuals (see graph below). Perhaps most telling was the fact that University of Michigan’s Consumer Sentiment reversed direction in March. That scenario is not a new story but calls attention to the need for vigilance and risk management going forward.
The real benefactor of the fed market’s strength, though, has been the feeder market. Feeder cattle futures have tacked on $10 during the past month as deferred contracts crossed $140. Consider that last fall’s market (Sept-Nov) averaged approximately $111.50 (basis CME feeder cattle index) – equivalent to an investment of about $55,000 per load. And for a little perspective here, $133/cwt is roughly equivalent to $1000/head; therefore, $140/cwt makes a 750-lb yearling worth $1050/head. The fall market quickly has prospects requiring nearly $70,000 worth of equity for every truck arriving at the feedyard. Clearly, the market is due for some correction but the discussion puts some context around the increasing capital structure required to feed cattle.
Discussion about capital requirements for feeder cattle doesn’t account for higher costs associated with feed inputs. To that point, the March 30 stocks report was somewhat of a watershed moment – it articulated the severe tightness within the grain complex. Corn stocks were pegged at 6.52 bil bu (versus 7.69 bil bu in 2010). Most significant, on-farm stock reserves represented 99% of the year-over-year decline. In other words, commercial sources have shortterm grain needs on hand but will have to drill deeper and/or increasingly incentivize the system to maintain pipeline supply. Clearly, producers have found prices favorable and locked in profits on some portion of their respective inventory. With that money in their pocket and knowing that supplies are tight, sellers are now in the driver’s seat. That means higher prices. Demand must be rationed going forward. There also remains questions about the other side of the equation: What price will be required for producers to part with what remains of their respective inventory holdings?
Establishment of this year’s corn crop is a crucial campaign. The market will scurry to purchase acres. However, as long as the global soybean (and cotton) market stays active, it will remain a fierce competitor for acres. Moreover, additional corn acres may be somewhat limited given the capital investment required to establish the crop. Speaking to the production side, there’ll also be much attention in coming months on potential yield. Despite several outliers, yield trends during the past fifteen years have become more predictable (see graph below). That’s a testament to the efficacy of plant technology and precision farming. From a market perspective, that resilience, though, is a double-edged sword: on one side the probability of major disappointments has been reduced over time; on the other side don’t count on corn availability getting bailed out by a favorable yield deviation.
However you look at it, given the demand structure for corn, one year is no longer sufficient to dig out of the hole. Bottom-line, the market will be extremely volatile as this plays out. And that will clearly play into the value of the feeder cattle market as we progress into the fall run; summer video sales will be upon us sooner than we think. Stay posted!
By Nevil C. Speer, PhD, MBA, Western Kentucky University