June 28, 2019
- The composite of meat prices moved lower as the season of peak demand gets underway
- Animal proteins fall 8.23% in Q2 and are only 0.20% higher so far in 2019- Lean hogs lead the way.
- Live cattle prices fall 12.09% in Q2
- Feeder cattle decline 5.78% in Q2.
- Lean hogs post a 6.82% gain in Q2 and are over 18% higher so far in 2019.
The animal protein or meat sector moved 8.23% lower in Q2, but lean hog futures continued to post gains over the past six months. The sector finished 2018 with a 3.73% loss but has moved 5.45% higher over the first six months of 2019. Meats ended 2017 with an 8.39% gain after falling 8.80% in 2016. In the meat markets, results can be skewed by term structure given the seasonality in the prices of beef and pork.
During Q2, the animal protein sector entered the 2019 grilling season which began on the Memorial Day weekend at the end of May. The bullish trend in the live cattle futures and range trading in feeder cattle futures came to an end as prices broke to the downside. Lean hogs posted gains as the outbreak of African swine fever spread from China to neighboring countries, increasing concerns about the availability of pork on a global basis. Additionally, the escalation of the trade dispute between the US and China in May caused some distortions in prices as they impact exports and the flow of meat supplies.
The iPath B Bloomberg Livestock Total Return ETN product (COWB) reflects price action in the meat markets. The Invesco DB Agriculture STF (DBA) over a 10% exposure to the cattle and hog futures markets.
Live Cattle Review
Live cattle futures moved 12.09% lower in Q2 and are 10.8% lower over the first half of this year after moving 1.91% higher for the year at the end of 2018. In 2017, live cattle gained 4.74% for the year. In 2016, live cattle futures lost 15.17% of their value. The nearby month live cattle futures contract on the CME traded in a range between $1.02300 and $1.30450 per pound over the first six months of 2019. Live cattle closed on June 28 at $1.10500 per pound basis the nearby futures contract.
It takes 18 to 24 months to raise a head of cattle; therefore, supply issues can take months, if not years, to impact the price of beef. The population of planet earth now stands at 7.714 billion people, around 20 million higher than at the end of Q2. In Asia, diets have changed as wealth has grown. A traditional rice-based diet now includes more complex proteins, which has increased demand for complex proteins like beef and pork in the region. It takes six pounds of feed for cattle to add each pound of weight. The average weight at the time of slaughter is between 1,200 and 1,400 pounds. Therefore, grain or feed prices have a significant impact on the price of beef. High feed prices often cause producers to take cattle to processing plants early at lighter weights to avoid paying the input costs. Lower feed prices often lead to heavier carcass weights.
As we head into the 2019 crop year in the US, floods delayed planting and prices of agricultural products that are the inputs in animal feed were higher in Q2. We are at the time of the year where uncertainty over the crop yields peaks along with price volatility in the grain futures markets. If we experience a period of drought across the US breadbasket the results could be devastating when it comes to the prices and availability of grains which could impact the prices and availability of animal proteins as the primary ingredient in their production is grain-based feeds.
When it comes to the inputs for raising cattle and all animal proteins, prices are sensitive to price action in the grain sector as feed prices are a primary input in raising animal protein. Soybeans moved higher by 1.75% in Q2 while corn exploded 17.88%, and CBOT wheat posted a gain of 15.35%. The trade issues between the U.S. and China continue to be a leading factor along with the weather when it comes to the path of least resistance of grain prices which will impact cattle and hog prices over the coming weeks and months.
The latest June WASDE report reflected demand weakness for the beef market. The WASDE told the beef market:
“The forecast for 2019 red meat and poultry production is reduced from last month as lower forecast beef, pork, and turkey production more than offset higher broiler production. The decline in beef production largely reflects lower steer and heifer slaughter in the second half of the year. The 2020 red meat and poultry production forecast is lowered from the previous month. Production growth for livestock and poultry is expected to be slower as producers respond to higher feed costs. The beef production forecast is reduced on lower expected steer and heifer slaughter as incentives to add weight on pasture slows the pace of feedlot placements. The beef import forecast is raised for 2019 on recent trade data, but the export forecast is reduced from the previous month on the current pace of beef exports to a number of trading partners. No change is made to the 2020 beef trade forecasts. For 2019, the cattle, hog, and broiler price forecasts are reduced from last month, reflecting current price weakness. For 2020, cattle, broiler, and egg price forecasts are reduced on continued demand weakness.”
Source: USDA June WASDE
Ranchers and animal protein producers often have a tough time dealing with volatile feed prices as they panic and buy on or near highs for fear of even higher prices and when the prices come down, they find themselves with feed price commitments that are much higher than market prices. In 2018, producers faced trade issues and increased competition from South American producers who have the benefit of weak currencies making their beef products more competitive in global markets. In May 2019, the trade issue with China escalated which could cause increased price distortions in the cattle market over the coming months. Grain prices had been stable before recent weeks allowing animal protein producers to proceed with their regular schedule as they prepared for the grilling season which began at the end of May. However, the recent price action in the grain futures market is pointing to higher feed prices over the coming weeks and perhaps months if the trend continues. A drought period in the US that sends grain prices higher could change the fundamental dynamics for cattle and hog futures.
The forward curve in live cattle is in backwardation from June 2019 to August 2019. The market then shifts to contango from August 2019 through April 2020 at which point it switches back to backwardation from April 2020 through August 2020. There is a small contango from August through October 2020. The current shape of the forward curve indicates that supplies of beef are a bit tight over the coming months.
There is lots of seasonality of this commodity, but it is highly sensitive to feed costs, which are the critical input in raising cattle. However, the trade issues between the US and China us likely weighing on export demand for Us beef.
The price of live cattle futures had been in a bull market mid-May 2018, but that ended in Q2.
The weekly chart of live cattle futures shows that price momentum and relative strength have declined into oversold territory where it is crossing lower. During the final week of the quarter, nearby futures put in a bullish reversal on the weekly chart. Open interest moved from 439,675 contracts at the end of Q1 2019 to 350,446 contracts at the end of Q2. The decrease of 89,229 contracts or 20.3% in the technical metric that measures the total number of open long and short positions in the live cattle futures market is not a technical validation of a continuation of the current bearish trend. Decreasing open interest as the price of a futures contract falls is not typically a technical confirmation of a bearing trend in a futures market.
As we move into Q3 2019 live cattle futures will move past the peak season of demand. Any deal on trade between the U.S. and China could provide support for the price of cattle and other types of meat. Additionally, a rebound in the Brazilian real and Argentine peso currencies could lift the price of beef over the coming weeks and months as both nations are significant exporters of cattle products. Meanwhile, I will be keeping my eyes on developments in the grain markets over the coming weeks as the delay in planting has put upward pressure on prices while the potential for drought conditions could cause lots of price volatility. Rising grain prices could change the behavior of cattle producers resulting in lighter carcass weights. Additionally, any outbreak of a disease in cattle herd around the world could cause wild price volatility as we recently witnessed in the hog markets with the African swine fever impacting Chinese supplies. Q2 ended with the live cattle futures market trading in a range.
Feeder Cattle Review
While live cattle futures contracts have a physical delivery mechanism, feeder cattle contracts are cash-settled instruments. Feeder cattle futures tend to attract more speculative interest. Feeder cattle outperformed live cattle prices in Q2 as the price suffered a smaller decline of 5.78% and were 8.06% lower over the first half of 2019. In 2018, feeder cattle futures gained 1.95% compared to their closing price at the end of 2017. Feeder cattle gained 11.92% in 2017 after moving 21.84% lower in 2016. Feeder cattle posted a decline of 23.2% in 2015, but in 2014 they gained 29.65% on the year. So far in 2019, the range in nearby feeder cattle contracts was from a low of $1.3215 to a high of $1.6140 per pound, and they closed Q2 closer to the lower end of the trading band. The same fundamentals affecting the live cattle futures are at play in the feeder cattle futures contract. At times the Feeder cattle contract leads the live cattle contract as speculators can push the price of the cash settled contract because of less liquidity when it comes to volume and open interest. Nearby feeder cattle futures closed on June 28, 2019, at $1.36850 per pound.
The forward curve in the feeder cattle futures market is flat from August 2019 through November 2019 when it slips into a small backwardation out to March 2020. A contango returns from March 2020 through May 2020.
The weekly chart in feeder cattle futures displays a bearish trend of lower highs and lower lows, but the feeder cattle were consolidating near the lows at the end of Q2. Relative strength is at the lower end of neutral territory, but the price momentum metric is in oversold territory. At the same time, open interest fell from 50,812 contracts at the end of Q1 to 49,359 at the end of Q2 or 2.9% over the period. Feeder cattle lagged live cattle in Q1, but that condition corrected in Q2 as they feeder cattle futures posted a smaller decline than the live cattle futures.
Lean Hogs Review
In 2015, lean hogs shed 26.35% of value. Lean hogs moved 10.62% higher in 2016. In 2017, lean hog prices moved 8.50% to the upside. In 2018, the price of pork posted a loss of 15.05% for the year. In Q2, hog prices moved 6.82% lower despite global supply concerns over an outbreak of African swine fever in China but were 18.25% higher for the first half of 2019. The range in this market was a low of 52.25 cents to a high of $1.02455 per pound for the first six months of 2019.
In the latest March WASDE report the USDA told markets:
“Forecast pork production is lowered from last month primarily as the pace of slaughter to date has been slower than WASDE-589-4 expected. Pork export forecasts for 2019 and 2020 are raised from the previous month, largely reflecting the removal of Mexico’s tariffs on U.S. pork products in late May. For 2019, the cattle, hog, and broiler price forecasts are reduced from last month, reflecting current price weakness. The 2020 hog price forecast remains unchanged as slower production growth and stronger exports support prices.”
Source: USDA June WASDE report
While the WASDE was neither bullish nor bearish for pork, the African swine fever lit a bullish fuse under the price of pork as producers in the US scrambled to roll out preventative measures that would lower the risk of the disease in the US. In 2014, lean hog futures rose to their highest price in history at $1.33875 per pound when PED killed over seven million suckling pigs. In March the price of pork was approaching the $1 per pound level on the active month June futures contract in a sign that the outbreak has significant consequences.
China is the world’s leading pork consumer, so trade issues between the U.S. and China had weighed on the price of the meat. Any agreement with the Chinese could propel the price of pork higher in 2019. However, the outbreak of the African swine fever in Asia has changed the dynamics of the pork market despite the trade issues that face the market and could provide another bargaining chip in President Trump’s pocket when negotiating with the Chinese who are finding themselves with a sudden shortage of the popular meat. China has significant strategic inventories of frozen pork, but they are likely falling. Meanwhile, the African swine fever has spread to neighboring counties, which could keep a bid under the price of pork in Q3.
Nearby lean hog futures settled on June 28 at 72.10 cents per pound on the nearby futures contract.
The forward curve in lean hogs in is contango from July through August 2019 and then moves into backwardation from August 2019 through October when a small contango is present from December 2019 through June 2020. There is a backwardation from June 2020 through December 2020. The forward curve in hogs reflects seasonal factors and could become highly volatile if the swine fever outbreak continues to worsen over the coming weeks and months. It is difficult to get a reading on the outbreak from China as their statistics can be suspect. Since China is the world’s leading consumer of pork, the nation is likely to treat supply data as a matter of national security.
The path of least resistance for the price of lean hog futures will depend on events surrounding trade and the disease outbreak over the coming weeks and months.
China is the world’s largest pork producer, but at the same time, the nation is the world’s biggest consumer of the meat. China bought the United States’ largest hog producer and processor, Smithfield Foods, in 2013. Given the current administration’s posture on trade with China and other nations around the world, we could see changes when it comes to food supplies raised, grown, and manufactured in the U.S. even when ownership is by foreign entities. Food supplies are a matter of national security. The Trump Administration has already rolled out restrictions on Chinese ownership of technology companies in the U.S. While Smithfield Foods is already owned by a Chinese entity, their location in Virginia and position as the largest pork processing company in the U.S. could present the administration with a conundrum in the case of a prolonged trade war when it comes to exports of pork products produced in the U.S.A.
Meanwhile, the technical position of the lean hog futures markets at the end of Q4 2018 highlights a market in neutral territory.
As the weekly chart highlights, lean hog prices took off to the upside in March as news of the swine fever broke. We are now in the peak season for demand as trade issues with China escalated over the second quarter, but the price has corrected lower.
Technical resistance on the weekly chart is at the May 2019 high at 93.025 cents per pound, but nearby futures already rose above that level to over $1 per pound. Support on the weekly chart is at the mid-February low at 52.25 cents and then at the October 2016 bottom at 40.7 cents. The open interest metric moved from 283,222 contracts at the end of Q1 2019 to 295,736 at the end of Q2, an increase of 12,514 contracts or 4.4% during the second quarter of 2019. Rising open interest alongside rising price typically validates a bullish price trend in a futures market. Momentum on the weekly chart was falling through neutral territory, but the daily pictorial of August futures was in oversold territory at the end of Q2.
The daily chart of August futures shows the pullback from prices at over $1 per pound as the escalation in the trade dispute has weighed on prices while African swine fever and the current peak season of demand provide support for the lean hog futures market.
Meanwhile, the monthly chart of lean hog futures shows price momentum and relative strength are in neutral territory and have been in a range since 2014. The hog market had been under pressure until swine fever broke out in Asia, but it failed to rise to challenge the 2014 peak. If pork shortages develop around the world, the critical level to watch is at the $1.34 per pound area, which is the record high from 2014. As Q2 ends, Q3 could be a time for price consolidation, but if African swine fever continues to spread, we could see another spike to the upside in the lean hog futures market.
The prospects for animal proteins in Q3 2019
As we move into Q3, the prices of cattle and hogs will continue to be sensitive to the news cycle on trade, but the end of the peak season for demand and African swine fever could inject volatility into the futures markets. When it comes to hogs, lower global supplies are likely to keep a bid under the price of pork. In the cattle market, consumers are likely to buy more beef over the coming months if fears of swine fever increase.
Cattle and hogs are both sensitive to feed prices, so changes in the grain markets could impact price action in meats during the third quarter of 2019 as the weather will determine crop yields during the fall harvest. Even a whiff of drought could cause explosive action in the grain markets, but average temperatures over the coming weeks could cause prices to move lower after the recent gains.
Additionally, both meats are always susceptible to other diseases like PED and mad cow issues or other conditions that can wipe out supplies in very short periods. The African swine fever is just the latest example of how diseases can wreak havoc with commodity supply and demand fundamentals as well as with technical analysis. Therefore, the animal protein sector can be highly volatile and full of surprises when it comes to the path of least resistance of prices.
Demographic factors continue to support demand for animal proteins as we move forward into the next quarter of 2019, but the ongoing uncertainty over trade is likely to influence prices. At the same time, the currency markets could add volatility in the meat markets as the Brazilian and Argentine currencies could move. An improvement in the South American foreign exchange instruments would likely support higher prices for cattle, and maybe even hog futures. The recent price action in the Brazilian real suggests that a recovery could be underway under the new Bolsonaro administration.
Volatility is a paradise for traders, but in the world of meats, it can be hazardous. Since price gaps are the norm rather than the exception in the meat markets, stop orders may not result in optimal execution for risk positions. For those who do not venture into the volatile futures markets, ETN vehicles such as the COWB or MOO products tend to replicate price action in the animal protein markets. The DBA ETF product has exposure to meat futures and is also a product that reflects the price action in other agricultural commodities. DBA could be a barometer of trade issues with the Chinese over the coming months. DBA is the product that has an over 10% exposure to the cattle and hog markets. The fund summary for DBA states:
“The investment seeks to track changes, whether positive or negative, in the level of the DBIQ Diversified Agriculture Index Excess Return™ (the “index”) over time, plus the excess, if any, of the sum of the fund’s Treasury Income, Money Market Income and T-Bill ETF Income, over the expenses of the fund. The index, which is comprised of one or more underlying commodities (“index commodities”), is intended to reflect the agricultural sector.”
The most recent top holdings of DBA include:
Source: Yahoo Finance
DBA held a 10.69% exposure to August live cattle and July hog futures at the end of Q2.
DBA has $432.18 million in net assets and trades an average of 351,240 shares each day. The net assets of this ETF product dropped by $38.9 million from the end of Q1 2019.
DBA moved from $16.47 at the end of Q1 2019 to $16.57 at the end of Q2, a gain of 10 cents or 0.61% for the quarter. DBA fell to a new all-time low at $15.42 in mid-May before the price of the ETF rebounded.
Aside from the current trade issues and seasonality, demographics continue to provide an upward bias to price on a longer-term basis. The bottom line is that more people, with more money, are competing for finite supplies of meat. In Q2 the world added another twenty million people to its ranks, and a significant percentage will likely be carnivorous.
When it comes to value, the prices of lean hogs are historically expensive compared to live cattle in the August 2019 futures contract as of the final day of the first quarter. Based on the closing prices of nearby futures on June 28, the spread was at 1.3730:1. The long-term average in the live cattle versus lean hog spread, dividing the price of the cattle by hogs, is around 1.4:1 or 1.4 pounds of pork in each pound of beef. The nearby spread in August was telling us that pork is trading at a marginally high historical price compared to beef at the end of Q2. The outbreak of African swine fever in Asia is a significant reason for the move in the historical price relationship between pork and beef prices.
The U.S. dollar index fell by 1.22% in Q2 and was 0.07% lower so far in 2019. A weaker dollar tends to support the prices of all raw materials, and meats are no exception. The dollar index ran into resistance at each new peak over in 2019, slowing the rise of the greenback. The potential for lower interest rates from the US Fed changed the dynamics for the dollar index in late June and that could carry forward into Q3.
If you are going to trade animal proteins over the coming quarter, make sure to keep a keen eye the trade issues between the US and China as they have the potential to be a driver of the prices of hog and cattle futures. Additionally, a decline in pork supplies in China could cause US pork to show up on Chinese dinner tables regardless of the tariffs as the nation has massive requirements to fulfill. The weakness in the Argentine peso and Brazilian real had also influenced cattle prices as both countries are exporters of beef to the world. As their currencies declined, their exports became more attractive in global markets, which could increase U.S. supplies. However, any recoveries could have the opposite impact and increase beef prices.
The spread of African swine fever beyond China’s border could be the most significant factor for the animal protein sector in Q3 with the path of least resistance of grain prices a close second. Either the outbreak or any surprises in the grain futures market could add lots of volatility to the prices of cattle and hog futures.
Meats are one of the most volatile sectors of the commodities market. I tend to look at each month in the futures arena as a separate commodity because of the significant impact of seasonality on the prices of both beef and pork. Keep the seasons in mind when approaching the cattle or hog futures on the long or short sides of the market. Many factors determine the path of beef and pork prices. Each year is always a new adventure in the carnivorous sector of the commodities market. As we move into Q3, the markets will begin to look forward to the season of low demand, which starts during the Labor Day weekend on the first weekend of September.
Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.