Summary

  • The composite of meat prices moved lower as the season of peak demand ends.
  • Animal proteins fall 3.51% in Q3 and are 4.19% lower so far in 2019- Lean hogs post gains for the year.
  • Live cattle prices fall 5.36% in Q3.
  • Feeder cattle rise 4.06% in Q3.
  • Lean hogs post a 9.22% loss in Q3 but are over 7% higher through three quarters of 2019.

 

The animal protein or meat sector moved 3.51% lower in Q3, but lean hog futures continued to post gains over the past nine months. The sector finished 2018 with a 3.73% loss and has moved 7.32% lower over the first nine 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 Q3, the animal protein sector exited the 2019 grilling season which began on the Memorial Day weekend at the end of May and ran through the early September. Live cattle and feeder cattle futures made lower highs and lower lows over the past three months. Live cattle futures dropped below the $1 per pound level for the first time since 2016. Lean hogs posted a loss even though the outbreak of African swine fever spread from China to neighboring countries, increasing concerns about the availability of pork on a global basis. The escalation of the trade dispute between the US and China in August weighed on meat 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 fell 5.36% in Q3 after moving 12.09% lower in Q2 and are 15.58% lower over the first nine months 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 97.175 cents and $1.30450 per pound so far in 2019. October live cattle futures closed on September 30 at 1.04575 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 7.734 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 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 only 0.69% in Q3 while corn fell 7.67%, and CBOT wheat posted a loss of 6.11%. Production of grains and animal proteins will shift focus to South America over the coming weeks and months as the winter season approaches in the northern hemisphere.

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

The forecast for 2019 total red meat and poultry production is lowered from last month as reduced beef, pork, and turkey production forecasts more than offset higher broiler production. Beef production is reduced from the previous month primarily on slower expected pace of fed cattle slaughter and lighter carcass weights in the fourth quarter. For 2020, the total red meat and poultry forecast is raised from the previous month on higher expected beef and broiler production. Beef production is raised from last month as higher expected first-half 2020 marketings support higher fed cattle slaughter in 2020. First-half carcass weights are also expected to support increased beef production. Beef import and export forecasts for 2019 are reduced, reflecting recent trade data; however, no changes are made to the forecasts for 2020. The cattle price forecast for 2019 is lowered on current prices and expectations of continued price weakness; the 2020 forecast is also reduced.

Source: USDA September 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. The ranchers faced the same issue in 2019. In August 2019, the trade issue with China escalated, which is likely to cause increased price distortions in the cattle market over the coming months. Lower grain prices allow animal protein producers to proceed with their regular schedule during the offseason.

The forward curve in live cattle is in contango from October 2019 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 February 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 highly sensitive to feed costs, which are the critical input in raising cattle. However, the trade issues between the US and China continue to impede 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, and the price continued to decline throughout Q3.

Source: CQG

The weekly chart of live cattle futures shows that price momentum and relative strength were in neutral territory. Open interest moved from 350,446 contracts at the end of Q2 2019 to 323,904 contracts at the end of Q3. The decrease of 26,542 contracts or 7.6% 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 bearish trend in a futures market.

As we move into the final quarter of 2019 live cattle futures will face the offseason. Meanwhile, 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. In Q3, both of the South American currencies moved significantly lower, which weighed on the price of beef. Rising grain prices always has the potential to alter the behavior of cattle producers resulting in lighter carcass weights. At the same time, any 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. Q3 ended with the live cattle futures recovering after probing below the $1 per pound level in September at the start of the offseason.

 

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 Q3 as the price gained 4.06% and were 4.33% lower over the first nine months 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 $1.27325 to a high of $1.62950 per pound, and they closed Q3 just below 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 closed on September 30, 2019, at $1.42400 per pound.

Source: CME

The forward curve in the feeder cattle futures market is in backwardation from October 2019 through March 2020 when it slips into contango out to September 2020.

Source: CME

The weekly chart in feeder cattle futures displays a bearish trend of lower highs and lower lows, but the feeder cattle broke higher above the recent higher low at the end of Q3. Relative strength and price momentum were both above neutral territory. At the same time, open interest fell from 49,359 contracts at the end of Q2 to 43,223 at the end of Q3 or 12.43% 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.

 

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 Q3, hog prices moved 9.22% lower despite global supply concerns over an outbreak of African swine fever in China but were 7.34% higher for the first nine months 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 nine months of 2019.

In the latest September WASDE report the USDA told markets:

The forecast for 2019 total red meat and poultry production is lowered from last month as reduced beef, pork, and turkey production forecasts more than offset higher broiler production. The pork production forecast is reduced on the current rate of slaughter in the third quarter and slightly lighter carcass weights. USDA’s Quarterly Hogs and Pigs report will be released on September 27 and provide information on producer farrowing intentions into early 2020. For 2020, the total red meat and poultry forecast is raised from the previous month on higher expected beef and broiler production. Pork, turkey, and egg production forecasts are unchanged from the previous month. The 2019 and 2020 pork export forecasts are raised from the previous month on recent trade data and expectations of continued strong global demand for U.S. pork products. Hog price forecasts are reduced slightly for 2019 and first-half 2020. The 2019 broiler price forecast is raised on recent price strength, but no change is made to 2020 price forecasts.

Source: USDA September WASDE report

 

The WASDE was bearish for pork, the African swine fever outbreak in China and other Asian countries continues to present a challenge for the pork market. The latest quarterly hogs and pigs report from September 27 showed a rise in supplies.

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 futures contract in a sign that the outbreak had significant consequences. However, as the peak season ended, hog futures moved lower as they reflect the oversupply conditions in the US.

China is the world’s leading pork consumer, so trade issues between the U.S. and China weigh on the price of the meat. Any agreement with the Chinese could propel the price of pork higher in the future. 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 spread to neighboring counties.

Nearby lean hog futures settled on September 30 at 65.45 cents per pound on the nearby futures contract.

Source: CME/RMB

The forward curve in lean hogs in is contango from October through June 2020 after which a backwardation is present from June 2020 through December 2020. There is a contango from December 2020 through February 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. A trade deal could 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 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 USA.

Meanwhile, the technical position of the lean hog futures markets at the end of Q3 2019 highlights a market in oversold territory.

Source: CQG

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 past the peak season for demand as trade issues with China escalated over the second and third quarters, and the price moved lower.

Technical resistance on the weekly chart is at the May 2019 high at 93.025 cents 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 295,736 contracts at the end of Q2 2019 to 262,618 at the end of Q3, a decrease of 33,118 contracts or 11.12% during the third quarter of 2019. Falling open interest alongside declining price typically does not validate a bearing price trend in a futures market. Momentum on the weekly chart was in oversold territory, but the daily pictorial of December futures was rising at the end of Q3 and put in a bullish reversal on the final day of the quarter.

Source: CQG

The daily chart of December futures shows that lean hog futures have been rising over the past few weeks.

Source: CQG

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 in the future, the critical level to watch is at the $1.34 per pound area, which is the record high from 2014. As Q3 ends, Q4 could be a time where the market will be sensitive to news on the trade front as seasonal demand will not return until the spring season in 2020.

 

The prospects for animal proteins in Q4 2019

As we move into Q4, 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. When it comes to hogs, lower global supplies are likely to keep a bid under the price of pork that will keep the meat above the 2016 low at 40.70 cents per pound. In the cattle market, consumers could purchase more beef over the coming months if fears of swine fever increase. However, the final three months of 2019 could be a time when prices continue to drift to the downside.

Cattle and hogs are both sensitive to feed prices, so changes in the grain markets could impact price action in meats during the final quarter of 2019 as the weather in South American will now determine production over the coming months.

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 both the Brazilian real and Argentine peso has been bearish as both currencies declined over the third 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 10.59% exposure to August live cattle and July hog futures at the end of Q3.

DBA has $356.49 million in net assets and trades an average of 289,973 shares each day. The net assets of this ETF product dropped by $75.69 million from the end of Q2 2019. The average number of shares traded each day also declined over the past three months.

Source: Barchart

DBA moved from $16.57 at the end of Q2 2019 to $15.86 at the end of Q3, a decline of $0.71 or 4.28% for the quarter. DBA fell to a new all-time low at $14.62 on September 9 but recovered by the end of the quarter.

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 Q3, 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 the second quarter. Based on the closing prices of nearby futures on September 30, the spread moved higher on the October futures contract and was at 1.5978:1. 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 at the end of Q2 was telling us that pork was trading at a marginally high historical price compared to beef. At the end of Q3, beef was trading at a historical premium to pork in October futures as the spread moved above the 1.4:1 level.

The U.S. dollar index rose by 3.51% in Q3 and was 3.43% higher so far 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 quarter above the 99 level. The prospects for lower interest rates from the US Fed have not weighed 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 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 increased U.S. supplies as export demand dropped. Any recoveries in the South American currencies could have the opposite impact and 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 Q4, the markets could drift lower without any exogenous inputs as we are heading into the heart of the offseason for demand.

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.