• The composite of meat prices moves lower in Q2- Dislocations in the supply chain distort beef and pork prices
  • Animal proteins fell 4.83% in Q2 and were 23.95% lower for the first half of 2020- The only sector posting a loss for the second quarter
  • Live cattle prices fell 9.99% in Q2
  • Feeder cattle rebounded 8.96% in Q2
  • Lean hogs post a 13.46% loss in Q2

The animal protein or meat sector moved 4.83% lower in Q2 and was 23.95% lower over the first six months of 2020. The sector finished 2018 with a 3.73% loss and moved 5.15% higher in 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. However, risk-off conditions in all markets weighed on the animal proteins over the first half of this year.

The first and second quarters of 2020 will go down in history as one of the most challenging periods since the Great Depression in the 1930s. Markets across most asset classes suffered price declines and a rollercoaster of volatility. Animal proteins were no exception. Live and feeder cattle futures prices moved in opposite directions in Q2. Both cattle markets were trading at lower prices than at the end of 2019. Lean hog prices declined significantly in Q2 and over the first six months of 2020. The pandemic caused significant dislocations in the meat markets. Ranchers and producers saw prices fall to extremely low levels as the peak grilling season that started at the end of May approached. At the same time, as coronavirus infected people all over the US and worldwide, processing plants shut down, causing bottlenecks when it came to supplies. While futures prices reached bargain-basement levels, supply shortages for consumers caused prices to rise creating an almost unprecedented dislocation in the meat markets.

Live cattle futures fell to lows in late April and staged a bit of a comeback in May and June. Lean hogs followed a similar path but were weaker than the cattle futures at the end of Q2. The pork shortage in China because of the 2019 outbreak of African swine fever did little to support the price of lean hogs. As I wrote in the Q1 report, “The lack of pork could have given rise to the outbreak of coronavirus. Some experts believe that the consumption of animal protein from “wet markets” in China could be the root of the global medical emergency that took hold of markets in February.” The Chinese have been less than forthcoming with the origination point of the virus, but the theory about the hog shortage and wet markets remains one possible explanation for the genesis of the global pandemic. However, the root cause of the pandemic may never be identified.

The iPath B Bloomberg Livestock Total Return ETN product (COWB) reflects price action in the meat markets. The Invesco DB Agriculture STF (DBA) has exposure to the meat futures markets.


Live Cattle Review

Live cattle futures fell by 9.99% in Q2 and were 26.50% lower so far in 2020. They rose by 0.67% in 2019. In 2018, they moved 1.91% higher for the year. 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 80.50 cents and $1.27550 per pound so far in 2020. Nearby live cattle futures closed on June 30 at 91.65 cents per pound.

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 7.795 billion people, around 20 million higher than at the end of Q1 2020. While coronavirus has claimed the lives of over 500,000 people in the world, population still expanded by around forty times that number over the past three months. 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 and lower prices.

The 2019 crop year in the US produced ample supplies to meet global requirements. The trade war between the US and China had resulted in gluts in the US, while shortages could develop in the world’s most populous nation. However, each year is a new adventure in agricultural markets. As we move into the third quarter of 2020, it will be the weather conditions in the US and around the world in the Northern Hemisphere that dictate grain and feed prices. The third quarter of the year is the heart of the growing season when dry spells can cause significant price volatility in the grain markets.

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 lower by 0.20% in Q2 while corn fell 0.66%. CBOT wheat posted a loss of 13.85%. Production of grains will now depend on the weather conditions during the summer months across the US grain belt and other producers in the northern hemisphere.

The latest June WASDE report reflected weakness for the beef market. The WASDE told the beef market:

The forecast for 2020 red meat and poultry production is raised from last month as higher forecast beef, pork, and broiler production more than offsets lower turkey production. The increase in beef and pork production largely reflects a faster-than-anticipated recovery in the pace of slaughter.

The 2021 red meat and poultry production forecast is raised from the previous month. The beef production forecast is raised on higher expected cattle placements in the second half of 2020 which will be marketed in 2021.

The beef import forecast is raised for 2020 on recent trade data and increased domestic demand for processing grade beef, while the beef export forecast is raised on higher expected beef exports later in the year. No change is made to the 2021 beef trade forecast.

For 2021, cattle prices are also raised on expected continued strength of packer demand in the first part of the year.

Source: USDA June WASDE

The USDA expects that beef prices will rise in 2021 from the current low level.

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. 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. The ranchers faced the same issue in 2019. In August 2019, the trade issue with China escalated, which caused increased price distortions in the cattle market over the coming months. While the US and China signed the “phase one” trade agreement on January 15 during Q1, Coronavirus swiftly replaced trade as the primary issue facing markets. Bottlenecks at processing plants created a unique challenge that caused shortages for consumers and glut conditions for animal producers.

The forward curve in live cattle is in contango from June 2020 through April 2021, at which point it switches to backwardation from April 2021 through August 2021. There is contango from August 2021 through October 2021. The current shape of the forward curve indicates that supplies of beef ample to meet demand over the coming months.

Source: CME/RMB

There is lots of seasonality of this commodity, but it is also highly sensitive to feed costs, which are the critical input in raising cattle. Risk-off behavior in markets caused by the outbreak of Coronavirus and bottlenecks in the supply chain caused live cattle prices to drop in Q1 and Q2.

The price of live cattle futures fell to a low in April and rebounded over the rest of Q2 from the low.

Source: CQG

The weekly chart of live cattle futures shows that price momentum and relative strength were on either side of neutral territory on June 30. Open interest moved from 264,447 contracts at the end of Q1 to 275,097 contracts at the end of Q2 2020. The increase of 10,650 contracts or 4.03% in the technical metric that measures the total number of open long and short positions in the live cattle futures market was marginal, considering that the peak season for demand began during Q2. Many markets experienced declines in open interest because of risk-off conditions.

As we move into the third quarter of 2020, live cattle futures will reflect the ongoing impact of coronavirus on processing plants and consumer demand. The decline in emerging market currencies has weighed on beef prices as Brazil and Argentina are both producers of cattle. The Brazilian real and Argentine peso currencies hit new historical lows during Q2. Argentina defaulted on its debt obligations in May. Meanwhile, any rebound in the currencies against the US dollar in Q3 could be supportive of prices. Moves in grain prices always have the potential to alter the behavior of cattle producers. Grains rallied on the final session of Q2. At the same time, an outbreak of a disease in cattle herd around the world could cause wild price volatility as we witnessed in past years when mad cow disease and African swine fever caused the meat markets to move dramatically for periods. Q2 ended with the live cattle futures above the lows for 2020. However, at the end of Q2 2019, the price was almost 19 cents per pound higher at $1.1050 per pound. The problems created by coronavirus and the bottlenecks at processing plants could set a stage for shortages in the future as ranchers raise fewer animals because of the economic distress in 2020. In commodities markets, the cure for low prices is typically low prices.


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 they rose by 8.96% after a 16.18% decline in Q1. Feeder cattle futures were 8.58% lower over the first six months of 2020 after a loss of 2.37% in 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. During the first half of 2020, the range in nearby feeder cattle contracts was from a low of $1.03950 to a high of $1.56500 per pound, and they closed Q2 just above the middle of the trading range. 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 settled on June 30, 2020, at $1.32850 per pound.

Source: CME

The forward curve in the feeder cattle futures market is in contango from August 2020 through November 2020 and then shifts to backwardation from November 2020 through March 2021. Contango returns from March 2021 through May 2021.

Source: CME

The weekly chart in feeder cattle futures displays that the animal protein has been trending higher since the early April low and has been consolidating at a higher level since late May. Relative strength and price momentum were both above neutral territory. Open interest rose from 32,767 contracts at the end of Q1 2020 to 36,744 contracts at the end of Q2 2020 or 12.14% over the period. Feeder cattle declined significantly less than live cattle futures over the first half of this 2020. At the end of Q2 in 2019, feeder cattle futures were four cents higher at $1.3685 per pound. Feeder cattle caught up with live cattle that were over 18 cents lower on a year-on-year basis at the end of Q2 2020.


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, but in 2019 the price rose by 17.14%. In Q1, volatile hog prices moved 26.92% lower despite global supply concerns over the 2019 outbreak of African swine fever in China. In Q2, the price continued to decline and moved another 13.46% to the downside. Over the first half of 2020, lean hog futures were 36.75% lower, and the worst-performing member of the animal protein sector and the overall commodity asset class. The range in the pork market was a low of 37.00 cents to a high of 90.175 cents per pound for the six months that ended on June 30. The low in the hog futures market was the lowest level since 2002.

In the latest June WASDE report the USDA told markets:

The forecast for 2020 red meat and poultry production is raised from last month as higher forecast beef, pork, and broiler production more than offsets lower turkey production. The increase in beef and pork production largely reflects a faster-than-anticipated recovery in the pace of slaughter. Pork production is unchanged from last month. The Quarterly Hogs and Pigs report will be released on June 25 and provide an indication of producers’ farrowing intentions for the second half of 2020; these are hogs which will likely be marketed in first-half 2021. The pork export forecast for 2020 is raised from the previous month, largely on the current pace of exports. No change is made to the 2021 pork trade forecast. The 2020 hog price forecast is reduced on current price weakness and increased supply pressure. The 2021 hog, broiler, turkey and egg price forecasts are unchanged from last month.

Source: USDA June WASDE report

The WASDE was bearish for pork as the USDA reduced price projections for 2020, but left them, unchanged for 2021. Coronavirus has weighed on markets across all asset classes, and lean hogs were no exception. The bottleneck at pork processing plants created price dislocations for producers and consumers. While the producers experienced low prices for their hogs, consumers paid top dollar for pork and experienced supply shortages.

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 May 2019, the price of pork was over the 90 cents per pound level on the active month futures contract in a sign that the outbreak had significant consequences. However, as the peak season ended, hog futures moved lower as they reflected the oversupply conditions in the US. Over the second quarter of 2020, the price fell to a nearly two-decade before recovering as the 2020 grilling season got underway. However, the price fell back below the 50 cents per pound level during the peak season for demand.

China is the world’s leading pork consumer, so trade issues between the U.S. and China weighed on the price of the meat throughout much of 2019. The agreement with the Chinese provided optimism for 2020. However, the outbreak of the African swine fever in Asia changed the dynamics of the global pork market. The disease could be one of the reasons for the outbreak of the virus that caused the global pandemic as Chinese consumers could have set the stage for Coronavirus in “wet markets” that offer a wide range of proteins that are far from standard in the west. China had significant strategic inventories of frozen pork, but they have declined. Meanwhile, the African swine fever spread to neighboring counties, as has Coronavirus. Tensions escalated between the US and China in Q2, which is likely to end hopes of pork exports from the US to the world’s most populous nation any time soon.

Nearby lean hog futures settled on June 30 at 45.175 cents per pound on the nearby futures contract close to the low end of the 2020 trading range.

Source: CME/RMB

The forward curve in lean hogs is in contango from July 2020 through June 2021. Backwardation is present from June 2021 through December 2021. The forward curve in hogs reflects seasonal factors. Chinese trade tensions and the progress over the global pandemic will dictate the price direction for lean hog futures.

We could see hog producers decrease output as a result of the economic problems over the first half of 2020. In the world of commodities, the cure for low prices is low prices, and ranchers and hog producers will limit the number of animals they raise after the problems at processing plants. A decrease in the amount of pork over the coming months could send prices even higher for consumers. They have not enjoyed the benefits of low futures prices because of availability problems caused by the supply chain. At the end of Q2 2019, the price of nearby hog futures stood at 72.10  cents per pound, almost 27 cents higher than at the same time in 2020.

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 US 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 US. They tightened those restrictions in Q2. While a Chinese entity already owns Smithfield Foods, 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 USA. Smithfield shipped pork to China in 2019 as the Asian nation paid the tariffs given the decline in local supplies. Chinese ownership of the Virginia-based company could become an issue over the second half of 2020.

Meanwhile, the technical position of the lean hog futures markets at the end of Q1 2020 highlights a market that was falling towards oversold territory.

Source: CQG

As the weekly chart highlights, lean hog prices moved to the lowest price in eighteen years in April when they reached 37 cents per pound. The price recovered in late April, but hogs have been declining since early May.

Technical resistance on the weekly chart is at the December 2019 high at 72.60 cents per pound. Support on the weekly and monthly chart is now at the Q2 low at 37.00 cents. The open interest metric moved from 229,366 contracts at the end of Q1 2020 to 225,597 at the end of Q2 2020, a decrease of 3,769 contracts, or 1.64% during the second quarter of 2020. Falling open interest reflects the risk-off conditions because of the virus. As producers could not send animals to processing plants, they closed price hedges.

Source: CQG

The daily chart of August futures shows that lean hog futures were in deeply oversold territory at the end of Q2 2020.

Source: CQG

Meanwhile, the monthly chart of lean hog futures shows price momentum and relative strength remained in oversold conditions at the end of Q2. The hog market experienced what turned out to be a blow-off low in April, but the recovery ran out of steam on the upside at below the 70 cents per pound level.

Meanwhile, if pork shortages continue to develop around the world in the future, the critical level to watch is at the $1.34 per pound area, which is the record high from 2014. As Q2 ends, prices at the supermarket are high with limited availability of pork. Producers have had to destroy animals because of shutdowns at processing plants. Q2 2020 was not a good period for producers or consumers in the hog and animal protein markets. The events could lead to shortages and far higher prices in the aftermath of coronavirus. As in beef, the cure for low prices in commodity markets is low prices.


The prospects for animal proteins in Q3 2020

As we move into Q3, the prices of cattle and hogs will continue to be sensitive to the news cycle on trade and Coronavirus. We are in the heart of a very challenging grilling season for the meat markets. In 2020, the dislocations could continue to keep the pressure on meat prices. Meanwhile, we could see far higher prices in 2021 and beyond. I would be a buyer of price weakness with tight stops looking for opportunities to build long positions in both cattle and hog markets.

When it comes to hogs, lower global supplies could keep some degree of a bid under the price of pork. In the cattle market, the same problems at processing plants could keep consumer prices high and producer prices under pressure for the second half of the year. At the end of Q3, the grilling season will end, which is the time of the year where demand tends to decline. However, 2020 is anything but an ordinary year. Any further outbreaks of the virus could cause a continuation of problems with the supply chain, exacerbating price dislocations in the beef and pork markets.

Cattle and hogs are both sensitive to feed prices, so changes in the grain markets could impact price action in meats during the second quarter of 2020 as the weather in the US during the growing season could cause periods of volatility.

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 was the latest example of how diseases can wreak havoc with commodity supply and demand fundamentals and 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 second half of 2020. At the same time, the currency markets could add volatility in the meat markets as the Brazilian and Argentine currencies could experience volatility as the real and peso are at or near historic lows. An improvement in the South American foreign exchange instruments would likely support higher prices for cattle, and maybe even hog futures. The price action in both the Brazilian real and Argentine peso has been bearish in 2020 as both currencies declined over the second quarter to new lows against the US dollar. As the number of infections of the virus rises in South America, it could impact supplies, creating even more confusion in the futures markets. The overriding factor in animal proteins and all markets has been a deflationary spiral and dislocations in the supply chain.

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. 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 fund pursues its investment objective by investing in a portfolio of exchange-traded futures.”

The most recent top holdings of DBA include:

Source: Yahoo Finance

DBA held exposure to the meats at the end of Q2, but it declined since the end of Q1.

DBA has $314.02 million in net assets and trades an average of 439,917 shares each day. The net assets of this ETF product rose by $19.82 million from the end of Q4 2019. The average volume rose by 55,897 over the past three months, which indicates increased interest in the agricultural commodities in Q2.

Source: Barchart

DBA moved from $14.07 at the end of Q1 2020 to $13.50 at the end of Q2 2020, a fall of $0.57, or 4.05% for the quarter. DBA fell to a new all-time low at $13.15 on June 26, 2020.

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 around 20 million people to its ranks, and a significant percentage will likely be carnivorous.

When it comes to value, the prices of lean hogs were historically inexpensive compared to live cattle in the nearby futures contract as of the final day of Q2. Based on the closing prices of nearby August futures on June 30, the spread moved higher and was at 2.1312:1 compared to 1.5257:1 at the end of Q1 2020 on June futures. 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 active month spread at the end of Q2 was telling us that cattle were trading at a high historical price compared to pork.

The U.S. dollar index fell by 1.76% in Q2 compared to the closing level at the end of Q1. However, it was still 1.34% higher over the first six months of this year. A stronger dollar tends to weigh on the prices of all raw materials, and meats are no exception. The dollar index made a new medium-term high in Q1 at 103.96 on the nearby futures contract and closed the second quarter of 2020 just below the 97.35 level. The lower dollar in Q2 did not provide support for animal protein prices.

If you are going to trade animal proteins over the coming quarter, make sure to keep a keen eye on the trade situation between the US and China as it has the potential to be a driver of the prices of hog and cattle futures. When it comes to South America, an increase in coronavirus infections could cause problems with supplies. Coronavirus continues to pose a significant danger to the global economy, as we learned throughout Q2.

Any diseases in cattle or hog herds always have the potential to cause increased two-way volatility. Mad cow disease sent cattle prices lower as consumers did not eat beef for a period. African swine fever impacted pork prices in 2019. The most significant issue for the future could be the price dislocations that are likely to lead to less production in 2021. We may see the more of an impact of coronavirus next year as supplies decline because of lower output. The cure for low prices in the commodities market is typically low prices, which is a theme to remember in the meat futures arena. Since animal proteins are year-to-year markets, 2021 and beyond could be a period where lower output leads to far higher prices at supermarkets, and in the futures markets.

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 2020, the markets could exhibit an upward bias after the low prices experienced in Q2. I am bullish on meat prices, but it could take until 2021 or later to rise. I would use tight stops on all long positions during Q3.

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.