Lean hog futures prices have hit another patch of volatility — mostly downward volatility, like last Thursday’s (Aug. 19) $2 drop — and although it’s impossible to point the finger at any singular, certain bearish influence, it does make you wonder, as 2022 inches closer, if the markets themselves are finally starting to reflect the uncertainty and industry-wide angst that results from California’s Prop 12 measure.

So far, most of the worry for the pork market has been centered on California itself, which voted in 2018 to pass the Farm Animal Confinement Proposition (Prop 12), making it illegal, starting in 2022, to sell pork inside the state unless it can be documented that the pork comes from an animal that was farrowed by a breeding sow that had at least 24 square feet of pen space (and other requirements). Not much of the pork currently available in the United States meets those requirements, so the state of California is expected to experience a dramatic shortage in some of its favorite meats, driving the prices of bacon in the grocery stores and carnitas tacos on the streets of Los Angeles sky high. (https://apnews.com/…)

There are still legal efforts that may prevent California’s Prop 12 from disrupting the nationwide pork supply chain (see https://www.dtnpf.com/…), but if it can’t be stopped, those of us in the rest of the country need to get ready for a sudden collapse in demand for pork from conventionally-raised hogs. Data from the National Pork Board’s Pork Checkoff shows California represented 8% to 9% of fresh pork retail sales and total pork retail sales in 2018, 2019 and 2020, both by dollars spent and volume purchased. Other estimates have suggested California accounts for as much as 15% of the nation’s pork consumption. However we slice the ham, if the traditional U.S. pork market suddenly loses 9% to 15% of its customer base because those customers won’t be able to legally purchase pork from conventionally raised animals, then prices will fall. There will effectively be two separate pork supply chains — a high-priced, scarce supply of Prop 12-compliant pork destined to be sold inside California and a glut of oversupplied conventional pork flooding cold storage everywhere else.

Lean hog prices typically trail the pork cutout by about $5 per hundredweight. So, if wholesale pork averages about $75 per cwt, then nearby lean hog futures would be expected to trade around $70 per cwt. This week, October pork cutout futures are around $101 per cwt and October lean hog futures are around $88 per cwt. That’s a $13 spread, but even that is well within the range of what is sometimes seen in this market, especially in comparison to mid-2020 when packers were struggling to stay open during the COVID-19 pandemic. The average spread through 2020 was $16 per cwt and the worst was $56 in mid-May when pork ($114 per cwt) was hotly demanded at grocery stores but overweight hogs ($58) had to be turned away from some packing plants and destroyed because there simply wasn’t enough capacity to process all the animals that reached their market weight on a biological schedule that had been set in motion months before.

Not to get too apocalyptic about this California Prop 12 scenario, but one wonders just how much damage could occur to the lean hog market in January 2022 when the law is scheduled to go into effect. As long as the packing plants stay open and continue to process their usual volume of hogs (approximately 470,000 head per day lately), things should be fine. But without California’s 9% to 15% of U.S. demand, what happens to all that pork? Some of it can be exported, sure; some of it can be stashed away in cold storage. But at some point, any market that is oversupplied with a commodity — in this case, market-weight lean hogs — will eventually push back with lower prices. Looking at history when the hog market was oversupplied, like 2016-18 when swine herd expansion outpaced slaughter capacity growth, we might expect prices to drop 10% to 20% compared with the pork cutout.

The problem with all of this is the uncertainty. If the industry had known all the details of Prop 12 compliance several years in advance, or even now, if we knew for sure what was going to happen in January 2022, then we would expect the market to work in an orderly way to motivate an appropriate-sized shift from conventional hog production to Prop 12-compliant hog production, and a subsequent reduction in conventional hog production, forestalling any concerns about a sudden glut of oversupply in early 2022. Unfortunately, those market signals haven’t happened, or haven’t happened clearly enough or fast enough. In fact, Iowa State University’s latest estimated returns for a conventional farrow-to-finish operation remain above $50 per head — highly motivating to expand production, not reduce it. Their estimated returns for hogs sold in June 2021 were $63 per head — the most profitable this industry has been since August 2014.

Pork that will be on sale in U.S. grocery stores in January 2022 will come from hogs that are slaughtered and processed in December 2021. It takes approximately 17 weeks to finish a hog on calibrated feed rations to reach its target market weight, so those hogs are just now being moved to finishing barns. Prior to that, the animals spent approximately six weeks in a nursery, and before that, approximately three weeks in a farrowing barn from birth to weaning. Therefore, the hogs in question were already born in mid-June. Their sows — the animals whose production practices determine whether the ultimate product will be Prop 12 compliant or not — were already bred back in February. Whatever market signals hog farmers needed to receive to adjust their production quantities in a non-chaotic way, they would have been needed months ago. It’s too late now to avert the coming crush of conventionally raised pork that will have to be absorbed by the non-California rest of the world. Pork cutout futures have some open interest for the October ($100 per cwt) and December 2021 ($95 per cwt) contracts, but nothing past that yet to indicate the market’s price expectations.

Pork packing companies have been communicating with the hog producers who supply their animals to determine what proportion of their market will be Prop-12 compliant by early 2022 and to offer premium bids for such animals, which will be tracked and processed through a separate supply chain destined for the California market. Individual producers have been making decisions about whether those premium prices will be enough to offset the expenses of retrofitting farrowing barns with the necessary group housing arrangements. Packer-owned hog production facilities themselves are perhaps best placed to take advantage of the premiums, having more certainty about what will be required to reach the California market and what the financial rewards might be. In March, Rabobank analysts estimated less than 4% of U.S. sow housing was able to meet the Prop-12 standards. By now, it’s likely that portion is somewhat higher after months of frantic installation of new sow feeding and handling equipment across the country. But will it be enough to meet the sudden shift into a two-path U.S. pork supply chain? So far, the futures markets have been only tentative at signaling what might happen.

Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached at masteringthegrainmarkets@gmail.com or on Twitter @elainekub.

(c) Copyright 2021 DTN, LLC. All rights reserved.

Note: This column drew on original research by Elaine Kub originally published in July 2021 (see pdf: “Elaine Kub analysis Prop 12 _07062021):

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In the commodity markets, we often say “the cure for high prices is high prices.” Either the tantalizing profits will motivate a huge surge in production of that high-priced commodity (and then the fresh oversupply will bring prices back down) or the forbiddingly expensive price tag will discourage end users from buying so much of the stuff (and then the drop in demand will bring prices back down). Either way, hot commodity prices never stay flat for very long.

The exception in 2021 seems to be beef, with wholesale prices still 36% higher than they were a year ago, and yet the country’s herd of beef cattle actually shrunk 2% between July 1, 2020, and July 1, 2021. In this market, there may be no easy “cure” for high prices, and the condition could persist for a few years due to two structural reasons.

The first very obvious reason why the cattle industry hasn’t been expanding its production of beef animals is drought. No matter how much the nation’s ranchers may want to increase their herd sizes and deliver more animals to market, it’s simply impossible when 65% of the West is suffering extreme or exceptional drought. In the state of Washington, only 4% of pasture and range is rated in good condition and exactly 0% is rated excellent. In the High Plains (North Dakota, South Dakota, Wyoming, Colorado, Nebraska and Kansas), only 28% of cattle country isn’t in some sort of abnormally dry or drought condition. The land simply cannot sustain its usual abundance of grazing animals this summer. Miserable ranchers are forced to make the anguishing decision to liquidate portions of their herds, and total U.S. beef cow slaughter has been running 12% above its usual pace, although it’s much heavier in specific drought-stricken regions.

So, that’s one disconnect between the market signal and the response — it wouldn’t matter what price the beef market was signaling, the industry right now simply is not able to respond with overall numbers when drought is this widespread.
There is another disconnect between the beef market’s prices and beef animal production — the market may be giving a signal (consumers buying hamburger for $5.00 per pound and wholesalers selling choice boxed beef for roughly $2.70 per pound), but that signal isn’t getting passed to the right people. Packers are pocketing those high beef prices, profiting hundreds of dollars for each fed steer or heifer they process, but the profit doesn’t make it farther down the supply chain.

Fed cattle prices are $20 per hundredweight better now than they were during the COVID-19-challenged meatpacking environment of a year ago, but they’re not what they could be, according to historical price relationships. During the 10 years leading up to 2020, live cattle futures prices tended to average about 60% of the price of choice boxed beef per hundredweight. In April and May of 2021, when choice boxed beef was $300 per cwt (or more) and fed cattle were only bringing $115 per cwt, this relationship dipped below 40%. At today’s boxed beef prices ($267 per cwt), we might expect to see live cattle prices at $160, but they are instead stuck below $125 per cwt (46%).

Things have changed in the meatpacking industry and no doubt there are legitimate reasons why the profit margins throughout the industry shouldn’t be expected to exactly match those of 10 years ago, but some of these changes could, nevertheless, be addressed. According to the White House’s Fact Sheet that accompanied the July 9 Executive Order on Promoting Competition in the American Economy, “Consolidation … limits farmers’ and ranchers’ options for selling their products. That means they get less when they sell their produce and meat — even as prices rise at the grocery store. For example, four large meat-packing companies dominate over 80% of the beef market, and over the last five years, farmers’ share of the price of beef has dropped by more than a quarter — from 51.5% to 37.3% — while the price of beef has risen.”

For traders, of course, the question is not about which price level would be fair or what prices should be, but rather what prices will be. Reductions in the beef animal breeding herd have already cast the die for production quantities through the next few years. Mama cows who are culled this summer won’t have a calf next spring, and expectations for the 2022 calf crop should be correspondingly lowered. This, in turn, means fewer market-weight steers and heifers should be expected in mid-2023, keeping supply tight.

The dairy herd has been expanding by 2% at the same time the beef herd has been contracting, but calves from the nation’s 9.5 million head of milk cows cannot fully fill the long-term void that will be left after this drought.
There may be implications for the feed markets too — specifically corn futures — but when it comes to demand for U.S. feed grains, a slightly lower number of domestic cattle on feed in 2022 and 2023 could be outweighed by the continued expansion of poultry feeding in this country, not to mention the chances of strong feed grains exports to other countries that are feeding their own expanding herds of animals.

Meanwhile, the highest heat in the beef market may have peaked back in early June, when choice boxed beef (wholesale) hit $340 per cwt (well short of the May 2020 record high of $475, but impressive nevertheless). It has since softened to $267 per cwt in late July. However, the benchmark wholesale prices for 90% lean ground beef remain as strong as they were in June but may now be plateauing beneath $280 per cwt. Perhaps there is only so much a grocery shopper is willing to pay for beef, no matter how delicious it is and no matter how much of that price ever gets passed back to the producers of the animals. It may not be possible for cattle producers to cure high prices with higher production this year, but as always in a commodity market, it could be consumers who moderate the prices with more hesitant demand.

Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached on that Contact Page or on Twitter @elainekub.

(c) Copyright 2021 DTN, LLC. All rights reserved.

Conventional wisdom (or at least the conventional wisdom among old cattle traders) says that when the stock market is doing well, cattle prices also tend to rise. Certainly we’ve seen this relationship, in mostly the opposite direction, during the last few weeks while equity traders have been panicking about the COVID-19 pandemic’s grim effects on global shopping and traveling. U.S. stocks have fallen almost 18% since the discovery of the coronavirus spreading in Europe. The April live cattle futures contract has fallen 13% during that same timeframe, but that shouldn’t be too surprising. Just about every market you can name has been headed downward during the coronavirus sell-off.

More curious, perhaps, is the way commodities (including cattle) kept heading consistently downward during mid-February, when the coronavirus was still mostly an Asian story, but the U.S. stock market kept stubbornly pursuing fresh all-time highs.

Sometimes, yes, stocks and cattle move in the same direction — and sometimes they don’t. It would be worthwhile, I decided, to investigate whether the conventional wisdom holds true in a mathematically rigorous sense.

Ultimately, there doesn’t appear to be any clear, consistent, constant relationship between stock prices and live cattle futures prices. The correlation of their weekly returns tends to wax and wane over time, perhaps with some seasonality of higher direct correlations during the early months of any year. Looking back at a trailing series of any six-month timeframe, the correlations of weekly returns in the S&P 500 Index of U.S. stock prices and the continuous front-month live cattle futures prices has ranged anywhere from 82% (a very strong direct relationship) to -42% (a very strong inverse relationship) and everywhere in between, including periods when there was virtually no relationship whatsoever.

Incidentally, that very strong correlation of 82% occurred during a similar timeframe to now — late 2008 into January 2009 — when most tradeable asset prices were all falling apart at the same time due to shared global financial panic. In the year 2020 so far (up to March 9), the weekly returns of the stock market and the weekly returns of the April live cattle futures contract have been 63% correlated. In plain English, that means both stock prices and live cattle futures prices have indeed been changing recently in the same direction, at the same times, and at roughly the same scale.

Over longer timeframes, a positive relationship is the most common one. During the 1990s, the overall correlation between weekly stock returns and live cattle futures returns was positive (barely) at 2%. During the 2000s, the correlation was positive 16%. During the 2010s, the correlation was 12%. So, what we’re experiencing now is consistent with the generally expected direction of movement, but it’s unusually strong.

Should it be? Does it really make sense for cattle prices to move higher when stock prices go up, and vice versa? (Let’s ignore the possibility that cattle prices somehow “cause” stock prices to go up or down.) The justification behind the original idea seemed to be that a higher stock market makes American consumers richer, and when American consumers are richer, they tend to go out and spend more money on beef. I wonder if any of that still makes sense in 2020.

First of all, does a higher stock market really put money into the American grocery shopper’s pocket? I doubt it. Since the 2009 recession, American stock ownership has fallen, but there are still a majority of people (55%, according to a 2019 Gallup poll) who own some stocks. However, only a small subset of those people own a large-enough stock portfolio to really have it affect their day-to-day budget decisions. Most people I know don’t check the balance in their 401K before writing a grocery list.

Now think of this in the other direction: a falling stock market, therefore, doesn’t really make American grocery shoppers any less affluent. As long as salaries, wages and real spending power doesn’t change, they should still feel as capable as ever of putting ground beef, roasts and steaks in their shopping carts. And we are seeing this resilience in the wholesale beef market. The choice beef cutout actually rose 0.3% in the week leading up to March 7 (the same week when live cattle futures lost 6%and the stock market flattened). Ground beef prices are actually still up 6.5% over year-ago prices.

The stocks-and-cattle price relationship made some sense, perhaps back in the 1970s and 1980s when American families were more price-sensitive about moving from meals of staple grains, potatoes, eggs, etc. toward more highly-desired proteins, like beef. There was a time when meatloaf was a treat for a family dinner. Today, however, it feels like a fast-food hamburger has become a baseline standard for many American diets (and let’s not even discuss any “plant-based” substances Frankenstein-ed into vaguely patty-shaped sandwich products). In the U.S., at least, ground beef has become almost as much a pantry staple as staple grains.

The higher price elasticity of demand for beef may hold true on a global sense, where large parts of the world are still transitioning over to more highly-desired, high-protein diets that include beef — but only if they can afford it. In that sense, coronavirus-related concerns for the global economy may indeed be related to the prospects of global beef consumption in 2020. Chinese consumers may be less likely to go out for restaurant meals and their restaurant meals may be much less likely to feature a prime U.S. steak. Cup-o-noodles could be the more common product consumed inside any quarantined apartment.

However, as DTN’s Livestock Market Analyst ShayLe Stewart pointed out to me, “One thing that I think people misunderstand is that the U.S. exports only 2% of its beef. So, if the coronavirus stays under control here in the U.S., the beef market could remain just fine. People will continue eating beef and buying beef.”

In the quest for understanding which commodities “should” be responding to the coronavirus panic, perhaps we should be looking elsewhere than the live cattle futures market (to say nothing of the poor, oversold feeder cattle futures market). A patchy history of correlations is not the same thing as real, fundamental justification.

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