Will Cattle Prices Make New Highs? Wow, what a terrific year for cattle. Almost everyone I have talked to did extremely well. Feed prices came down dramatically, while pasture ground showed dramatic improvements. The question is can we continue to keep the bull run alive? I think we can, at least through the early part of 2015. From everything I’m hearing we should continue to see declining beef production for the first half of 2015, but beyond that things will start to tighten up. Keep in mind during each of the past few years the calf population has averaged a steady decline, that more than likely will not be the case in 2015. In fact most insiders are thinking the calf population will finally start to increase. Actually, some are saying the biggest increase since 1997. With corn and feed prices stabilizing and the herd starting to increase, it clearly appears that margins will start drifting back towards much more normal levels. Meaning profits for those in the cattle business, though profitable, will more than likely be nothing like they were in 2014. Another concern I have and reason I suspect there will be a lid kept on dramatically higher prices, is the fact we are seeing bigger gains in pork and poultry production. In other words there could be more heavy competition from the cheaper alternatives. I have lots of buddies with cow-calf operations. How they approach their business this Spring will be interesting. Do they hold on to their heifers and continue rebuilding or is this the time to take some chips off the table and cash out? We have to recognize the structural changes and shifts that may soon be hitting the cattle industry. Often the easiest thing to do is simply continue down the same path.
Most of us are well aware of the tight cattle supplies which have led to record high beef prices over the last year. If you haven’t bought a new pair of shoes lately, you may not have noticed how high the price of leather goods has climbed as well. Wholesale hide prices are up around 17% this year. That’s on top of the 17.4% increase seen in 2013. Heavy native steer, the predominant hide type, is now selling at the highest levels seen since the government began tracking it in 1998. And it’s not just high-end leather that’s skyrocketing either. The price of splits – which are used to make suede or coated to make sports shoes – have also climbed to record levels. And here’s the really cruel twist to leather goods producers – as their costs continue to climb, so does demand. As the economy has improved, consumers are once again splurging on everything from fancy bags to luxury cars decked out with leather interior. With producers margins being so high, they’re unfortunately not reaping much reward in the end. The Scottish Leather Group is a classic example. They reported an 18% gain in revenues this past fiscal year, but their hide costs were up 16%, eating up nearly all their profit. Beef prices have a little bit of a buffer when it comes to adding weight, which has been able to somewhat offset the supply shortage. Hides however see no gains from the added weight. About half of all global leather supplies are used in footwear; another 30% is used for furniture or auto interiors; and the rest is used in wallets, belts, bags and other accessories. So far, wholesalers and retailers alike have been less shy about passing on the additional costs to consumers than grocers have. Various industry groups estimate that prices at the retail level have been raised anywhere from 10% to 20% and again, that is on top of price increases seen in 2013. They also predict that prices at all levels will continue to climb for at least the next year, if not longer.
Hedging Cattle Near The Highs? There have been some questions as of late about why I elected to hedge or lock in profits in the cattle market if I remain a longer-term bull? I guess the easiest way to explain it is the fact I am worried about the quant’s, algo’s and money-mangers flushing out of their long positions as fears of a slowing global economy and the spreading of Ebola ripple through the marketplace. On top of the macro geopolitical fears, I’m also concerned that we might start seeing a lot more competition from cheaper alternatives like chicken and pork. From what I hear poultry production is expected to jump by 5-7% next year. Bottom-line, both pork and poultry are much quicker and easier to ramp up than beef production. Hence cheaper pork and poultry prices might start to weigh on beef demand. From the bullish side, I understand the slaughter continues to run -15% to -20% behind last years pace. At this level there is simply no way beef supplies can fulfill current demand. This obviously sets the stage for a major clash between the bears and the bulls. The traditional fundamentals are obviously keeping me a longer-term bull, but understanding that “money-flow” is king, the current negative macro and geopolitical fears are making me a bit more nervous. I believe with cash supplies staying tight, there will be some good rallies between now and year-end. I think it’s smart to use these rallies to hedge and eliminate possible unforeseen downside price-risk.
Pasture ground all across the US is showing signs of recovery. According to the latest drought monitor, about 48% of pastures and rangeland were in “Good to Excellent” condition. In other words the best we have seen for this time of year since 2010. In return ranchers are finally starting to see some light at the end of the tunnel, perhaps even starting to build back the domestic cattle herd which had recently shrunk to over a 60 year low. I’m not pointing out anything but the obvious, and while it takes years to reverse a decline in animal supply, the recovering pastures, record-high beef prices and the increasing availability of cheap feed are providing the incentives and groundwork for some to start expanding their herds. What does this mean for longer-term prices? I don’t think a whole lot. Even after the early-August price declines, Live Cattle and Feeder Cattle prices are still significantly higher than they were a year ago. Consumer ground-beef and boneless sirloin steak prices remain near all-time highs, and many inside the trade believe the tight supplies will structurally keep the bull market in place for at least a few more years. I would have to concur. Even with signs of a turn around in the herd numbers, US beef production probably won’t begin to increase until 2017 as ranchers keep heifers for breeding instead of sending them to slaughter. Let’s also not forget back on August 12, the USDA estimated beef production will drop another -1% in 2015 to 24.4 billion pounds, the lowest in nearly 20 years and the fifth straight annual decline. The good news here is that drought conditions are stabilizing in much of the Midwest and the Great Plains. Despite places like Texas, who is still experiencing some severe drought in areas and lagging behind the national average for pasture conditions, there are now thoughts that major cattle-producing states including Kansas and Oklahoma might be off the severe drought map all together by the end of October. According to the National Weather Service and NOAA, “topsoil” in most of the cattle states is wetter than the 10-year national average. Bottom-line, market dynamics are starting to allow ranchers to begin the slow rebuilding of the US cattle herd. Their efforts will be buoyed by some of the cheapest prices for feed costs we have seen since 2009.
I have been a major cattle bull the past several months, but I’m starting to think the market is getting a bit “toppy”… at least nearby. There is no debating the fact the US cattle herd has dramatically shrunk in size, now the lowest in the past 60-years. But I’m more and more worried that each major push higher is going to start prompting more long fund liquidation. With this being the case I would suggest talking with your individual advisory about a strategy that can help provide some downside protection. The cattle market has been extremely strong as of late and very rewarding, I just get the feeling we could be due for a bit of pullback in the weeks ahead. Keeping with our theory of practicing proper “risk-management,” now seems to be the time to reduce and lower our risk as we head into the second-half of 2014. Making forward sales or finding alternative ways to protect your downside makes the most sense to me at this juncture. Don’t get overly greedy!
I have been asked several times the past few months about my thoughts pertaining to cattle prices… As I have said repeatedly, I don’t think the “TOP” has been put in. In fact, many of you have asked or wondered if we are ever going to make another cattle or feed cattle hedge. I haven’t recommended anything because I still truly believe prices are heading higher longer-term. The “do nothing” approach has worked like a charm so far. Lets just say I learned my lessons from the grain markets the past few years. Certainly we could see a few setbacks along the way, but I think we are setting up for an other explosive push higher before yearend. Keep in mind we are possibly looking at the smallest combined June and July placements in history. We are also seeing for the first time (in my memory) both fed and cattle slaughters well below the previous years pace. I’m also thinking the August “Cattle-on-Feed” report could bring us another round of extremely bullish numbers. With packer competition already fierce, we have to ask ourselves what will be like this winter? I don’t want to get overly bulled up or way ahead of myself, but I’m really starting to think supplies could get even tighter out in the 4th quarter of 2014. In turn prices still have more upside potential. Bottom-line, I still see NO compelling reason to hedge or step in front of this freight train at this time. Risk-mamagement is always our primary concern, hence we should always be paying close attention to the downside possibilities, but in this case I still believe the upside potential is greater than the downside risk. Therefor we are going to continue moving forward “doing nothing.”
It was recently reported that Japan has agreed to lower tariffs on imports of frozen beef and cut duties on chilled beef from Australia. In a nutshell this will give Australia a more clear advantage over US beef exporters. Keep in mind the Japanese beef market is worth billions. As of last year Japan imported near 550,000 tons of beef. About 55% of those imports came from Australia, close to 35% from the US and a smaller portion from New Zealand. The fear moving forward is if the US government isn’t able to strike a deal with the Japanese similar to what they made with Australia, US exporters could see a 70-80% reduction in their Japanese demand.