Market sees a large year-end rally

Markets
Dec 31, 2010
by WLJ

Cattle feeders enjoyed an extended Christmas, trading fed cattle actively Wednesday afternoon at $4.00-$6.00 over the prior week’s market. Kansas feeders traded at $106-$106.50, and $107.00 in Texas, northern Plains dressed trade was at $168-$170. Most trade was completed Wednesday with light cleanup trade on Thursday. Show lists were cleaned out and market analysts anticipate show lists to get larger this week because of this market rally that is expected to soften mid January. Last week marks the sixth straight week that fed cattle have sold for a dollar or more.

Slaughter levels remained strong regardless of the shortened holiday processing schedules. Weekly slaughter was about the same as the week earlier, but running well ahead, about 35,000 head over last year’s pace. Packers are agressively processing around 130,000 head a day despite negative margins, minus $22 on Wednesday, on an average buy of $102.30 on prior week’s cattle. Cutout values rose sharply during the week which doesn’t appear that it will have much effect on margins with packers paying $6.00 more for cattle. The cutout value was at $163.41 for Choice and Select was at $157.50 last Thursday with the load count starting to pick up slightly.

Troy Vetterkind of Vetterkind Brokerage said that Live Cattle Futures are approaching near-term price targets of $107 in December and $110 in February and these are the price points that it appears the market wants to get to before cooling off any. Feeder cattle have price targets up to $125-127 and it appears this is where the market wants to go before we see any type of reaction. Open interest continues to build on the higher futures trade so there are no signs the market is finished going up yet. I wouldn’t doubt we continue to move higher into the first or second week of the new year before we see any type of setback in the futures or cash now.

This would especially hold true if it were to achieve the above-mentioned  price targets. There are not enough traders around the market right now to absorb the fund buying, so the path of least resistance will be higher for the next two weeks. When we do get into the first couple weeks of January, we will see some index fund rebalancing, to where they will have to sell some of their livestock and grain holdings and move into other commodities, which will have some sell pressure around the cattle complex.

The supply and demand fundamentals are becoming perplexing and many market analysts don’t see how packers can maintain their processing levels with negative margins. Beef inventories are growing. The USDA’s latest Cold Storage Report showed there was 441 million pounds of beef in cold storage at the end of November which was 6.3 percent above October and 2.3 percent above the same month a year ago. Feedlot performance has also been great. A relatively mild winter is allowing carcass weights to rise. The average steer carcass weighing was at 855 lbs. last week, up 3 pounds from the prior week, and up 5 lbs. from the same point a year ago. 

There wasn’t much to report in feeder cattle markets last week due to the holidays and low offerings. That which did trade was met with good demand, but volume makes it difficult to spot any trends in these markets. Many auction markets were closed for the holiday season; Oklahoma city was closed for the final two weeks of the year. The feeder cattle index was at $120. and feeder cattle futures prices were steady.

The country auctions that did sell reported strong advances on the handful of cattle offered. The  South Dakota state summary reported light weight steers up $2.00-5.00 higher and light heifers up $5.00-7.00 higher. Steers over 600 lbs. were called $2.00 lower. One load of steer calves, weighing 800 lbs. was reported at $124.25. Davenport, WA, reported light receipts, but steers in the 400-500 lb. range averaged $135 and 700-800 lb. steers were at $106. There is excellent demand for light weight steers and heifers and solid demand for the heavy calves and yearlings ready to go to the feed lot.

For the year, packers will have processed just over 33 million head, 2.5 percent more cattle than last year. Both the pork and poultry segments of the meat industry processed fewer numbers than last year. The beef industry should end the year with 26 billion pounds, having produced a little more than one percent more than last year.

Forecast

There has been a great deal of discussion about the condition of the U.S. cattle herd over the past year. Darrell Mark, Ag economist from the University Nebraska spelled out the inventory situation in detail last week. He said, “In the last month, I've had the great opportunity to visit with a lot of cattle producers and present market price situation and outlook information. Discussing the price forecasts and industry health for the next year has been both exciting and perplexing. It is pretty easy to be bullish on cattle prices as forecasts call for still higher prices again next year, but it is quite a bit harder to be bullish on the overall industry's market structure when it is uncertain which operators will be around to enjoy those high prices.

“Why am I bullish on prices? Cattle inventories are at historically small levels. Why am I bearish on market and industry structure? Cattle inventories are at historically small levels. Clearly, the declining beef cow herd, low heifer retention, and small calf crop point to lower cattle supplies and beef production for the next couple of years, which alone is supportive to price levels. However, this continually smaller cattle inventory is becoming profoundly more important due to the long-run impacts it has on industry structure.

“In an attempt to satisfy the short run demand for beef with a smaller cattle inventory, the industry has been slaughtering more females - both cull cows and fed heifers. In fact, even back in May 2010, heifer slaughter accounted for around 28 percent of federally inspected (FI) slaughter. By the end of 2010, over 30 percent of FI slaughter was fed heifers. During that same time, cow slaughter increased from about 17 percent of FI slaughter to over 20 percent. Steer slaughter dropped from about 53 percent to 47 percent of FI slaughter. The problem of course with trying to maintain beef production in the short run by elevating female slaughter is that it leaves fewer females in the breeding herd, which makes beef production in the long run that much lower.

“Consider the female-to-steer slaughter ratio. It has been increasing for the past five years and neared 100 percent in 2010. The historical impact on beef cow numbers is fairly evident when this ratio is at or above 100 percent - cow numbers decline for several more years. It isn't until we see a female-to-steer slaughter ratio closer to 90 percent that the beef cow herd inventory begins to increase.

“The declining size of the beef cow herd and resulting calf crop has important implications on the cattle feeding and beef processing sectors. Each is running below capacity for the last couple of years, which is economically inefficient. Most margin businesses such as these would prefer to be close to 90 percent capacity or more. Cattle feeders in Nebraska were closer to 75 percent last summer. Although that has increased to more typical levels this fall as calves were placed, it isn't true for cattle feeders in parts of the country with higher costs of gain. Similarly, this causes beef packers to run well below their optimal capacity utilization. If the long run trend towards fewer cattle continues, that suggests that there will be fewer feedyards and fewer beef packers and processors as well. Not only would that be devastating for the families and companies that find themselves squeezed out of the market, but it would have a significant impact on employment and other indirect impacts on the rural communities where they are located. Further, this isn't of course isolated to the feeding and processing sectors of the industry. Cow-calf producers will be similarly affected.

“The other important market structure impact that emerges from the declining herd size is related to beef demand. Commercial beef production is forecasted to decline about 2 percent in 2011 and another 2 percent in 2012. Commercial pork production will be about steady this year and increase 1-2 percent in 2012. Poultry production, however, is forecasted to grow about 2 percent in 2011 and another 3 percent in 2012. As the beef industry continually produces less beef each year, consumers necessarily will eat less beef and prices will rise. Although it depends on the relative quantity and price changes and the elasticity of demand, this will likely translate to a decrease in beef demand. Further, higher beef prices could cause consumers to shift away from beef to poultry. While this isn't a certain outcome yet, the stage appears to be set for this to play out. The biggest "if" in this scenario is whether or not consumers will return to higher levels of beef consumption once retail supplies of beef begin growing, which will be several years down the road. If they don't, the size of our industry could forever be reduced, unless exports grow even more rapidly than they have been.

“So, what is a producer to do with information like this that is apparently bullish on prices and somewhat bearish on the industry structure? For the cow-calf producer, it is time to create heifer development budgets and weigh those returns against potential feeding profits. For the cattle feeder, there isn't any clear-cut answer as to what to feed when cattle supplies grow increasingly tight next summer after the 2010 calf crop has been placed. They will have to make plans for operating at lower capacity.

“There will certainly be a lot to sort out in the upcoming year, but cattle producers, as a whole, always do the ‘right’ thing according to the economic incentives in the market. The resiliency of the industry will therefore continue into 2011 and beyond, but we need to be prepared for it to look a little different by the end of this next year.” —WLJ

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