Jan 27, 2012
Disconnected markets

It looks like cattle markets are going to start the winter spring rally, at least that’s what many market watchers are assuming. Feeder cattle just seem to get higher and higher and fed cattle are starting to rally a bit after the Christmas slump. Looking forward on the deferred feeder cattle futures, cattle are trading at $158 from spring through fall. It’s hard to think of them going much higher, especially when you consider cattle feeders are looking at March close outs of $137, and packers are losing a $100 per head right now. It’s great that calf prices are at all-time highs and that everyone’s doing well.

Most everyone I know in this business is an eternal optimist, especially cattle feeders. Taking on feeder cattle under these market conditions takes a lot of fortitude, especially since there has not been a decent hedge shown yet for spring fed cattle. Packers will have to start cutting back on beef production and try and raise beef cutout values back in to the mid $190s to narrow the gap. Beef retailers are also getting a little tired of negative margins, too. We’re sure to test consumer resolve again for higher retail beef prices because that appears the only road out of a pending mess, and doesn’t appear likely to happen.

When you look at all these market indices and how they fit together, you quickly realize something isn’t quite right. Ever since New Years, wholesale beef prices have been in a tail spin. Ironically, it has affected Choice product more than the Select beef which has been relatively stable compared to the higher priced product. Choice values have dropped more dramatically and have closed the Choice/Select spread to less than $6, which makes you wonder what happened to the Walmart influence that seemed to give the Choice cutout a boost late last year?

We all know that this beef market has been supply driven the last couple years. Cow/calf producers have never had better economic signals to expand cow herds and it’s showing with bred heifer markets trading between $1,400 and $1,700 a head.

However, we do have to make beef affordable if we want to maintain a healthy industry. I’m really concerned about the cattle feeders and the packers connecting the dots and finding some sustainability and continuing to do their job. These guys are all buying into negative margins and have been for a while. At some point, these markets are going to revalue and create some profitability at the back end of the production chain.

There are a lot of mixed signals in the cattle markets right now, with calf prices at all-time highs and feed costs still on the high side. Feeders have already bought into seemingly unrealistic breakevens to feed more cattle. There isn’t an excessive amount of grass available to take calves from 500 pounds to larger feeder weights. You could literally say cattle feeders are buying cattle with reckless abandon. Right now, both feeders and packers are trapped in a pool of red ink.

The good news is that the feed grains situation may improve dramatically this next year, Steve Meyer, economist at the Chicago Mercantile Exchange, pointed out just after the last supply and demand report. “The quarterly grain stocks survey has been producing plenty of surprises in the last two years and this last release threw another curve ball at the market.”

USDA opted to leave ethanol use unchanged despite the reports of record high ethanol production.

It is likely that the surge in ethanol production was because refiners rushed to maximize use ahead of the end of ethanol credits, suggesting a surge in corn usage. At this point, markets will start to focus on early planting estimates for corn’s 2012-13 marketing year.

There is broad expectation that corn acres could increase by as much as 3 million acres this spring, somewhere around 94 million acres, and with reduced feed use, could send ending corn supplies next year up over 1.6 billion bushels, the largest corn carryover for many years, which could pressure corn prices below $5, reducing livestock feeding costs.

Lower feeding costs will certainly lower beef production costs next year. But how is this industry going to find a reasonable end to $137 fed cattle and a wholesale beef cutout value that is struggling to reach a new high, and eliminate negative feeding and packing margins? The markets will change to get things in a more realistic value. The big questions are when and how, and who will weather the storm. — PETE CROW