- The composite of meat prices moves higher as live cattle lead the way
- Animal proteins rose 10.14% in Q4 and were 5.15% higher in 2019- Lean hogs post the most significant gain for the year
- Live cattle prices rose 19.24% in Q4
- Feeder cattle up 2.05% in Q4
- Lean hogs post a 9.13% gain in Q4
The animal protein or meat sector moved 10.14% higher in Q4 as live cattle futures price posted a double-digit gain over the final three months of 2019. 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.
During Q4, the animal protein sector rose despite being in the heart of the offseason. Live cattle futures made lower highs and lower lows over the three months. Feeder cattle prices were stable. Lean hogs posted a gain as the outbreak of African swine fever that spread from China to neighboring countries, increased concerns about the availability of pork on a global basis. The ongoing trade dispute between the US and China continue to impact prices. The “phase one” deal in December lifted lean hog prices.
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 live cattle and hog futures markets.
Live Cattle Review
Live cattle futures rose by 19.24% in Q4 after falling 5.36% in Q3 and were 0.67% higher in 2019 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 93.400 cents and $1.30450 per pound in 2019. October live cattle futures closed on December 31 at 1.24700 cents 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 7.754 billion people, around 20 million higher than at the end of Q3. 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 has resulted in gluts in the US, while shortages could develop in the world’s most populous nation.
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 4.08% in Q4 while corn fell 0.06%, and CBOT wheat posted a gain of 12.71%. Production of grains and animal proteins are now focusing on South America as we are in the heart of the winter season in the northern hemisphere.
The latest September WASDE report reflected strength for the beef market. The WASDE told the beef market:
“For 2020, the total red meat and poultry forecast is increased from last month as higher broiler production more than offsets a lower beef production forecast. Beef production is reduced on slightly slower pace of both fed and nonfed cattle slaughter in the first half of the year. Beef imports for 2019 and 2020 are raised from last month on trade data to date and expectations that demand for processing-grade beef will remain strong. Exports for 2020 are lowered to reflect a slightly weaker pace of sales; the forecast for 2020 is unchanged. The cattle price forecast is raised for fourth-quarter 2019 based on recent data and the strength is expected to carry into 2020.”
Source: USDA December 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. 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 could cause increased price distortions in the cattle market over the coming months. While hopes for a “phase one” trade agreement between the two sides rose in Q4, no deal occurred by the end of 2019. At the very end of December, US President Trump said he would sign a deal in mid-January in Washington DC.
The forward curve in live cattle is in contango from February 2020 to April 2020. The market then shifts to backwardation from April 2020 through August 2020, at which point it switches back to contango from August 2020 through June 2021. The current shape of the forward curve indicates that supplies of beef ample to meet demand over the coming months.
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. Trade issues continued to distort export demand for US beef in 2019.
The price of live cattle futures was in a bull market throughout Q4.
The weekly chart of live cattle futures shows that price momentum and relative strength moved to overbought territory. Open interest moved from 323,904 contracts at the end of Q3 2019 to 378,965 contracts at the end of Q4. The increase of 55,061 contracts or 17% in the technical metric that measures the total number of open long and short positions in the live cattle futures market is a technical validation of a continuation of the current bullish trend. Increasing open interest as the price of a futures contract rises is typically a technical confirmation of a bullish trend in a futures market.
As we move into the first quarter of 2020, live cattle futures will begin to look forward to the peak season for demand in the US that starts at the end of May. Meanwhile, progress in trade negotiations 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. In Q4, both of the South American currencies remained not far above long-term lows, which is not typically a bullish factor for the price of beef. Moves in grain prices always have the potential to alter the behavior of cattle producers. 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 cause the meat markets to move dramatically for periods. Q4 ended with the live cattle futures closer to the highs than the lows of the year.
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 underperformed live cattle prices in Q4 as they rose by 2.05% after rising 4.06% in Q3. Feeder cattle futures fell 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. In 2019, the range in nearby feeder cattle contracts was from a low of $1.26000 to a high of $1.62950 per pound, and they closed Q4 just near the middle 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 settled on December 31, 2019, at $1.45325 per pound.
The forward curve in the feeder cattle futures market is in backwardation from January 2002 through March and then shifts to contango from March 2020 through October 2020. A marginal backwardation returned from October 2020 through November 2020.
The weekly chart in feeder cattle futures displays that the animal protein has been trading in a range and leaning higher. Relative strength and price momentum were both a bit above neutral territory. Open interest rose from 43,223 contracts at the end of Q3 to 49,684 at the end of Q4 or 14.95% over the period. Feeder cattle lagged live cattle in Q1, but that condition corrected in Q2 and Q3 as they feeder cattle futures outperformed the live cattle futures. In Q4, they substantially underperformed 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 Q4, hog prices moved 9.13% higher after falling 9.22% in Q3 despite global supply concerns over an outbreak of African swine fever in China. Lean hogs were 17.14% higher in 2019. The range in this market was a low of 52.25 cents to a high of $1.02455 per pound for the year that ended on December 31. The hogs were the best-performing meat of the year.
In the latest September WASDE report the USDA told markets:
“Pork export forecasts for 2019 and 2020 are lowered to reflect slower-than-previously expected growth in exports to several markets although the recent trade agreement with Japan is expected to mitigate the decline in total exports. The 2019 and 2020 hog price forecasts are reduced on current price weakness.”
Source: USDA December WASDE report
The WASDE was bearish for pork. However, the report came out before the announcement of the “phase one” trade deal between the US and China. The African swine fever outbreak in China and other Asian countries continues to present a challenge for the pork market.
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, 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.
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 could set the stage for the price of pork to move higher in 2020. The outbreak of the African swine fever in Asia has changed the dynamics of the global pork market. The disease likely provided a bargaining chip in President Trump’s pocket when negotiating with the Chinese who are found themselves with a severe shortage of the popular meat. China has significant strategic inventories of frozen pork, but they have declined. Meanwhile, the African swine fever spread to neighboring counties.
Nearby lean hog futures settled on December 31 at 71.425 cents per pound on the nearby futures contract.
The forward curve in lean hogs in is contango from February 2020 through June 2020, after which a backwardation is present from July 2020 through December 2020. There is a contango from December 2020 through June 2021. The forward curve in hogs reflects seasonal factors. 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 trade deal has the potential to cause demand for US exports to China to skyrocket.
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 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. 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.
Meanwhile, the technical position of the lean hog futures markets at the end of Q4 2019 highlights a market that was rising above 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 off-peak season for demand. As the trade war de-escalated in December, the price of lean hog futures moved higher.
Technical resistance on the weekly chart is at the July 2019 high at 87.50 cents per pound. Support on the weekly chart is at the mid-August low at 59.30 cents and then at the August 2018 low at 48.925 cents. The open interest metric moved from 262,618 contracts at the end of Q3 2019 to 282,389 at the end of Q4, an increase of 19,771 contracts, or 7.53% during the final quarter of 2019. Rising open interest alongside rising price typically validates a bullish price trend in a futures market. Momentum on the weekly chart crossed higher in oversold territory and was above a neutral reading at the end of Q4.
The daily chart of February futures shows that lean hog futures were in overbought territory at the end of 2019.
Meanwhile, the monthly chart of lean hog futures shows price momentum and relative strength were on either side of neutral territory at the end of Q4, but the price has 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 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 Q4 ends, 2020 will be a year where the market will be sensitive to the news on the trade front, and seasonal demand will return during the spring season of 2020, which the forward curve reflects.
The prospects for animal proteins in Q1 2020
As we move into 2020, the prices of cattle and hogs will continue to be sensitive to the news cycle on trade, but the offseason for demand and African swine fever could inject volatility into the futures markets during Q1. When it comes to hogs, lower global supplies are likely to keep a bid under the price of pork. In the cattle market, consumers could purchase more beef over the coming months if fears of swine fever increase. I expect prices to mostly follow trade progress during the first three months of 2020.
Cattle and hogs are both sensitive to feed prices, so changes in the grain markets could impact price action in meats during the first quarter of 2020 as the weather in South American will give way to the uncertainty over the US crop as planting will commence at the end of Q1.
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 the most. 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 both the Brazilian real and Argentine peso has been bearish as both currencies declined over the fourth quarter against the US dollar.
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 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 a 10.13% exposure to February live cattle and February hog futures at the end of Q4.
DBA has $358.91 million in net assets and trades an average of 263,303 shares each day. The net assets of this ETF product rose by $2.42 million from the end of Q3 2019.
DBA moved from $15.86 at the end of Q3 2019 to $16.56 at the end of Q4, a rise of $0.70 or 4.41% for the quarter. DBA fell to a new all-time low at $14.62 on September 9 but has been making higher lows and higher highs since then.
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 Q4, 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 expensive compared to live cattle in the nearby futures contract as of the final day of 2019. Based on the closing prices of nearby futures on December 31, the spread moved significantly higher on the February futures contracts and was at 1.7459:1 compared to 1.4995:1 at the end of Q3. 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 at the end of Q4 was telling us that pork was trading at a low historical price compared to beef.
The U.S. dollar index fell by 2.99% in Q4 and was 0.34% higher in 2019. 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 Q3 at 99.33 on the nearby futures contract and closed the final quarter of 2019 just above the 96 level. Lower interest rates from the US Fed did not weigh all that much on the US currency because other central banks around the world have pursued accommodative monetary policies.
If you are going to trade animal proteins over the coming quarter, make sure to keep a keen eye on 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 continued weakness in the Argentine peso and Brazilian real could also influence 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 increased U.S. supplies as export demand dropped. Any recoveries in the South American currencies could have the opposite impact and further increase beef prices.
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. However, African swine fever could have the opposite effect if Chinese supplies continue to drop over the coming months.
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 2020, the markets will begin to look towards the peak season of demand that starts in late May.
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.