Although the cattle market has rallied lately, many in the industry clearly doubt the move will persist beyond the short run. Fed cattle changed hands at an average $119.79 in Nebraska last week. And while August live cattle futures ended last week at $117.67, the expiring contract set back to $116.92 on Monday. Moreover, deferred contracts extending out through next summer are trading at significant discounts.
A major factor weighing on the cattle price outlook is the ongoing expansion of the U.S. cattle herd. Doane expects the domestic cattle population to rise 1.9% annually to 93.8 million head on January 1, 2017. That would represent a 5.9% increase since the cyclical low of 88.526 million from January 2014. Actually, herd expansion almost surely began in 2013. One can certainly argue the cumulative rise over the past two to three years is an underlying cause of the big surge in slaughter rates seen since late spring. As the following chart shows, weekly kills have routinely run 8%-10% over mid-2015 rates since early June.
Herd expansion probably isn't the direct cause, because it usually takes at least two years before calves born in the U.S. are ready for the packing plant. Thus, the animals now exiting feedlots were born in 2013 and 2014. This disparity is more evident when one compares recent slaughter totals to the 10-year average on the chart. This year's kills only seem large when compared to last year's extremely low totals. The chart below offers a different perspective on these weekly numbers.
Obviously, many of the large weekly and annual swings on this chart reflect big industry cutbacks during holiday weeks, especially around Christmas and New Years. The red line depicts the weekly totals, while the blue line represents the percent annual change in slaughter rates. The shift from levels hugely below year-prior rates during 2014 and early 2015 becomes more evident. In addition, despite the fact that recent highs are below the peak numbers from 2014, the percentage differences from mid-2015 make them look greatly elevated.
Bearish traders will argue the larger kills simply reflect accelerated spring yearling placements into domestic feedlots. The numbers of replacement animals entering large U.S. lots during February, March, April, May and June posted annual increases of 10%, 5%, 10%, 7% and 3%, respectively. We believe the spring downtrend in those percentages reflects the extreme bearishness that dominated live cattle futures at that time (as well as the increased feed costs imposed by the spring soybean/grain rally).
Spring futures and price action also encouraged feedyard managers to accelerate sales of their animals. If the market is doomed to break down in a few weeks, the producer has tremendous incentives to market those animals as quickly as possible. Accelerated sales also imply the cattleman doesn't have to feed those animals over a full feedlot stay. I would contend that accelerated marketings have caused summer slaughter totals to bulge, with persistently active sales being likely to greatly reduce these annual increases in late summer and fall. Another result of this phenomenon has been a substantial drop in steer dressed weights, which I consider to be the best indicator of feedlot currentness. I regard the comparative drop in weights as confirmation of speedy feedlot sales.
This third chart puts recent steer weight readings in context. They obviously reached extremely high levels late last year, but have recently moved below those from spring-summer 2015. As pointed out in the past, annualized reductions in steer weights usually mean producer sales are quite current and that they have few extra animals to sell in such conditions. Indeed, producers are often 'pulling cattle ahead' in these circumstances, which means they're selling cattle before they're well finished and will often grade Select rather than Choice or Prime. The resulting shortage of market-ready cattle also tends to improve producer leverage when bargaining with packers. Furthermore, the lighter animals translate into diminished beef production per head.
Such situation have historically tended to prove quite supportive of cattle prices, with the resulting bull markets often tending to last longer and move higher than previously anticipated. In such instances, presumed 'walls of cattle' expected to show-up a few months down the road have routinely failed to materialize as a result of the sizzling sales pace. Of course, there are no guarantees such bullish developments will occur. Still, both cyclical and seasonal factors suggest the fed cattle market will rally significantly during the coming weeks and months.
This final chart above puts recent cattle price action in context, showing the 10-year average pointing to an early-to-mid-July tendency for a market bottom, despite the big losses suffered through much of 2015 and the major lows posted in October and December. While I'm not wildly bullish toward the fed cattle outlook at this point, I believe a 'realizing' market where nearby futures are forced to rally up toward stubbornly firm or rising cash prices could occur through late 2016 and early 2017. Weak beef demand seems likely to limit price gains, but the situation could improve even further if/when grocers lower retail beef prices to the point where the various cuts become more attractive to consumers.