Is the rally over?

Apr 30, 2010

Futures markets have been kind to the beef business over the past few months. Sometimes I don’t think we would have had this kind of price discovery without the futures markets, but then again, cash did lead the futures market around for a few weeks. Feeder cattle markets were also pushed into very high territory by the futures and the feeder cattle index never really caught up until last week, as the two converged when the April contract went off the board.

It’s interesting to see who is doing what in the futures markets. The Commodity Futures Trading Commission (CFTC) Commitment of Traders Report shows us that the commercial industry, which includes cattle feeders, were selling more live cattle contracts last week than the week before. Conversely, money managers, whom we like to call speculators, were continuing to buy long contracts in live cattle. In the long run, the speculators are helping make this market. You’ve got to love them when they’re long, but it’s easy to hate them when they go short.

Most market analysts seem to think this market is going to take a breather for a few weeks and perhaps rally again in mid-May. The choice beef cutout reached $170 last week and then fell back on lower volume. Packers have continued to stay in the black throughout this entire episode and are processing more cattle. It appears that every segment of the beef industry has enjoyed some of the benefits of this rally.

With the government talking about a financial reform bill, one has to wonder if or how this legislation will impact trading of commodities. Price discovery in cattle markets has been a big issue in years past and some groups continue to make it an issue. However, with approximately open interest of 366,000, it’s clear that the tool is being heavily used. It’s no wonder ag commodity traders have deferred to the futures markets as the primary valuation tool. If it was a bad tool, no one would use it, but that’s not the case.

The point is this: Futures and options are a tool that every cattleman can use to manage their risk, and we all know how volatile these markets have been. It would be beneficial to learn how to use them rather than cuss them and not realize what your options are. Sure, you can win big or lose big on the cash markets, but you need to know what your risk level is.

Last week, R-CALF proposed that the CFTC limit participation of speculative sellers by limiting their trading volume to 25 percent of open interest. R-CALF claims that will remove volatility while still providing liquidity. They also proposed that the only people who should be allowed to trade commodity futures are commercial participants who either receive or deliver the commodity. The group said evidence that the live cattle futures market is no longer functionally capable of serving as an effective risk management tool for U.S. cattle producers includes data showing that the physical hedgers’ share of the long open interest in the live cattle futures market declined from 67.6 percent in 1998 to 11.7 percent in 2008.

The funny thing is that packers are inherently long position takers and feeders are short position takers. Last week, the commercials were short 185,159 contracts and long 15,605 contracts. Meanwhile, money managers were long 126,746 contracts and short 11,059 contracts. Swap dealers were long 106,548 contracts and short 3,179 contracts. So, producers have sold the contracts at high levels and the speculators have bought the contracts at high levels. The market pretty much works the way it’s supposed to. But when those speculators start taking the short side, watch out! We’ll have a repeat of 2008, which was exacerbated by the financial fallout and then a rapid increase in unemployment. At that point, we had too many cattle on feed for the market to absorb.

This year, producers have been careful not to carry too much inventory. Cattle on feed are at a very good point. If cattle feeders maintain the aggressive marketing that we’ve seen the past month, they will maintain very current supplies until August. The number of cattle that have been on feed for more than 120 days will be at or below 85 percent of last year for the next four months. The typical 15 percent drop in prices from the winter high to the summer low may not develop this year, but it would still be a good idea to get your cattle priced today. — PETE CROW