The U.S. Department of Agriculture’s annual cattle inventory report confirmed what every cattleman suspected — supplies of stocker and grazing cattle will be short this year. Typically that means higher prices, and the first couple of weeks of 2013 saw a rally in stocker and feeder markets. But much of February found buyers sitting on their hands at many auctions.
Market analysts say two major factors have played into this year’s cattle markets: the prospects of continuing drought across the Central Plains, and the reality that feedyards continue to struggle with heavy losses.
“Producers need to keep in mind the margin environment of the segments above them,” says Cattle-Fax market analyst Lance Zimmerman. “The losses have come to feedyards consistently now for the better part of 12 months — more or less three turns of cattle have been losing money. Packers are in a similar profit struggle recently, and that means it is going to be difficult for the feeder market to gain momentum in the fashion that it has in previous years.”
That negative margin environment is typically destructive to feeder-cattle demand, and it presents a real risk to the 2013 feeder-cattle market. As producers look to buy cattle, Zimmerman says, they need to know their breakeven cost of production and have a risk-management and marketing strategy ready to execute.
“August feeder-cattle futures prices are at $153 per hundredweight and the average Kansas 550-pound steer received bids around $170 per hundredweight,” Zimmerman noted in late February. “That dictates the gross margin for those calves at $350 per head after accounting for historical basis. That suggests a breakeven cost of gain at $1.16 per pound before accounting for interest, health expenses, labor and freight. Most producers can make that work in their favor — if we get rains that provide adequate pasture to run stockers through the summer months. Hedging can provide the protection they need, and buying puts can be beneficial to lock those prices in and allow some top-side price flexibility.”
Stocker operators must also make a determination of what they believe the market opportunity will be in August. Zimmerman says those cattle have the potential to be marketed as early as December if they sell in early August, which means the Choice/Select spread is typically at a high. Quality considerations regarding health and genetics of calves purchased now could provide more opportunity for higher prices into that late-summer marketing time.
Chicago feeder-cattle futures have offered opportunities to hedge grazing cattle this year, but Zimmerman says stocker operators need to make those decisions based on their labor and management costs.
“Each operation will be a bit different, and the type of calf going into those programs will influence purchase price, performance and sales price parameters significantly,” Zimmerman says. “Volatility over the last few years has been extreme, but stocker operators have managed to increase profit margins through most of the last five years. Last year, we started to see that trend break some, and it isn’t time for this segment to get greedy. If a profit exists when the calves are purchased, consider locking it in at that time. Waiting for the market high or pushing off a decision for another $1 or $2 per hundredweight is not good business if an acceptable profit is available now.”
Sidebar: Can herd expansion begin in 2013?
By John Nalivka, president, Sterling Marketing, Inc., Vale, Ore.
Continued herd liquidation during 2012 further reduced the U.S. cattle inventory to 89.3 million head, down about 2 percent from a year earlier, the lowest since 1952. The beef cow herd on Jan. 1 posted a 3 percent drop from a year earlier, as the drought that began during June of last year was devastating to crop and forage resources, and this followed severe drought in the southern Plains during 2011. Obviously, the prospect of further herd liquidation has ramifications across the entire beef supply chain, but perhaps the question is even more pressing in the face of a 17 percent drop in the size of the beef cow herd over the past 17 years.
What will cause cattle producers to slow liquidation and begin to expand herds? There are three drivers to the cattle cycle — forage, lifestyle and the prospect of making money (the profit motive), not necessarily in that order.
The prospect for making money has probably been the dominant factor over the past few years as prices have reached record levels. During last year’s drought and the Texas drought in 2011, markets remained strong. In fact, during 2011, U.S. beef cow slaughter was up 4 percent from a year earlier (up 21 percent in the southern tier of the United States) but the size of the beef cow herd fell only 2 percent during that year, indicating that the number of first-calf heifers calving and entering the cow herd during 2011 was up substantially. In fact, it was the highest since 1993. Last year, the opposite occurred. Beef cow slaughter during 2012 was down 12 percent from a year earlier while heifer retention fell.
Economically, this makes perfect sense. Cattlemen sold older cows during a drought with record cull-cow prices during 2011, but had more heifers calving that had been retained two years earlier. At the same time, fewer heifers were held as replacements during 2011 to be bred and calved during 2012. So, during last year’s drought, cow slaughter from a younger herd was down but there were also fewer first-calf heifers calving and entering the cow herd.
If demand remains relatively strong, and this is a risk, tighter cattle supplies suggest stronger prices. So, in an environment of a sharp decline in cattle numbers, producers had greater incentive to hold herds together despite high feed prices as they anticipated continued high prices and opportunity for profit.
Barring another major drought and/or significant drop in prices, the cattle inventory will likely bottom this year with increased numbers beginning to show at the beginning of 2015. Increased heifer retention to build herds will lead to tighter supplies of cattle over the next two years.