"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Saturday, April 12, 2014

Looking Closer at the Pork Market

Not that long ago I sent up a post about the Quarterly Hogs and Pigs Report issued by the folks over at the USDA. I took issue with some of that data as it conflicted with their own weekly slaughter data. Whether that is here or there no longer matters in terms of the futures market reaction because ultimately, the markets always have the last word on these things.

I have to always laugh at the commentary coming out of gold community when the breathless remarks about flash crashes makes the rounds as if somehow such things are unique to only the gold market. Those who regularly trade the ag markets can vouchsafe for the sharp increases in volatility and extreme intraday swings in price that now, sadly, seem to be the new normal.

The hog market has reached levels of volatility that I have never before witnessed in my entire trading career of nearly 25 years. I remarked the other day that they are much more like the old pork belly contract that some of us cut our trading teeth on. Just this week we went from limit down to limit up in the matter of less than two hours time without the least bit of news. I could blame it on JP Morgan attempting to suppress the price of hogs at the behest of the feds, but alas, that would be as ridiculous as those who continue to regale us with flash crash chatter and 1% mandated price caps in gold.

The reason for all this goes back to that Quarterly Hogs and Pigs Report we got at the end of last month. The simple truth is no one is really quite sure what the true impact from that devastating PED virus has been in the industry. We all know that it has been severe; what we do not know is the actual number of deaths resulting from it. In effect, the industry is still dealing with a huge unknown. That is contributing to the wild swings in price as those who disbelieve the report continue to buy any breaks in price while those who believe the report continue to sell any rallies in price.

One thing appears to be sure - the report has quelled the panic buying that was evident in the product market with wholesale pork prices now coming back down to earth after reaching levels that were unheard of. AT the risk of boring those who are primarily interest in gold, bonds and currencies and not the ag markets, the price of the pork trim that goes into making hot dogs, for example, jumped from near $0.63/pound at the beginning of the year to a eye-popping $1.45/pound earlier this month. That is an increase of over 100% in 4 months' time! I wonder if the folks over at Oscar Meyer and BallPark have recovered from their shock yet!

There is one bit of evidence however that shows, in spite of the impact from the disease, things are not quite as dire as many expected.

Take a look at the following chart. It is the total pork production here in the US for each week of the year. I have included the year 2012 just for a reference point but am primarily interested in this year's production compared to the previous year ( 2013) to gauge the impact from the virus.

The BLUE line is this year's production while the BLACK line is last year's. Notice that we started out the year with pork production exceeding last year's levels as the impact from the virus was not yet becoming evident. In early March the impact then hit and did it ever hit! By the middle of that month, total pork production fell some 32-33 MILLION POUNDS below the level in 2013. The panic then started big time. Prices for wholesale pork, which were already rising in anticipation of a shortage this spring/summer took off in earnest as apocalyptic type predictions began circulating through the industry.

I quipped to one of the news wire reporters that the US hog herd had been completely eradicated by the virus.

Please note that I am in no wise attempting to make fun of the severe impact that those hog producers who have sadly been impacted from this virus have had to contend with. I have the utmost respect for our hog producers who battle regulations and other difficulties associated with feeding us.  We are talking about their livelihood being impacted and that is no joking matter. I am however merely pointing out how news stories take on a life of their own whenever prices start escalating. It was the same thing with gold back when it first cleared $1800 and then $1900 a couple of years ago. Some things never change in the markets, remember that.

Back to the chart however - notice what appears to be happening with that BLUE line however in relation to the BLACK line as the month progresses. For all practical purposes, it is at the same exact level as that from 2013. How to explain this when we have so many pigs being killed by this scourge of a virus?

The answer is in the weight chart shown below. Once again we have the BLUE line for this year ( 2014 ) in comparison to the BLACK line ( 2013 ). Hogs are coming in between  7 - 9 pounds heavier than at the same time last year. The average reader will be tempted to say, " So what?".

Look at it this way, if weekly hog slaughter comes in near the 2 million mark, that is an extra 14 - 18 million more pounds of pork each week. Please note that I am not allowing for waste - this is just for the sake of simplicity. What is happening is that hog producers, especially those who have suffered losses and who do have remaining hogs, are feeding them to heavier weights in an attempt to mitigate some of the impact from the disease.

Hogs, like cattle, are priced by weight. Assuming the quality of the animal is the same, a heavier weight hog or steer is going to fetch more money from the packer for its owner. Now an extra 7 - 9 pounds may not sound like much, but if you are selling a fair number of animals, that extra money from the same animal certainly helps out.

What appears to be happening is that while hog slaughter numbers are currently running below last year's levels, the total amount of pork actually being produced is higher than the losses from the disease would seem to indicate at face value. Heavier hog weights are offsetting a large amount of the reduced slaughter numbers.

The big question that the industry has at this point is whether or not we have seen the worst of the impact from the virus as the recent Quarterly Hogs and Pigs Report indicated we would or if the worse is yet to come this summer. No one knows for sure and that is what is contributing to the volatility in this market.

I will say this however, the fact that total pork production is running pretty close to last year's levels at this point, makes me very suspect that the extremely high prices we are currently seeing in the wholesale pork trade is going to continue for long. As a matter of fact, I am coming around to the opinion that we have now seen the worst ( or best depending on one's perspective ) of the price rises in pork and that this year's peak in prices seen earlier this month are the BEST we are going to see for the remainder of the year. Please note that I am speaking of the entire carcass and not individual cuts which may fluctuate in price as seasonal demand ebbs and flows. Still, in the case of trim for example, how can one justify a price increase of over 100% in 4 months' time when pork production is now running only slightly behind last year's levels? That is pure panic that produced such a thing - it is certainly not based on reality.

Hog producers might want to take notice of this and plan your risk management program accordingly. This industry has had some very difficult times over the last few years with corn prices soaring to all time highs near $8.00 and meal prices out of sight. Many producers have lost money for so long that they think they are hallucinating when they see these stratospheric prices in hogs and relatively cheap - by recent comparison - feed costs. I am glad for them as they are due for a break. However, one of the dangers of a market which is soaring upward and in which sentiment becomes so overwhelmingly bullish is that producers get caught up in the emotion and caution goes out the window. Why? Because they are just sure even higher prices are yet to come.

I would caution them to avoid making the mistake of allowing euphoria and greed to take the place of a sound risk management program. Hogs are at levels, even after the big retreat in price as a result of the Quarterly Report, where producers can lock in some incredibly, perhaps once in a lifetime kind of profits. Could they go higher? Sure they could - markets can do almost anything especially in our modern age of idiocy due to computers making trading decisions instead of human beings. But, they could also go lower, much lower IF, and this is a big IF, USDA's numbers actually get confirmed as being reflective of what is happening on the ground. Why take the chance especially if you can lock in GUARANTEED outstanding margins on some of your expected 2nd and 3rd quarter production. If you want to keep some out as gambling stocks that is fine, but why bet the farm on even higher prices especially seeing that the profits that the Board is currently guaranteeing you are ripe for the picking.

Also consider one more thing and this is from the technical perspective - look at the positioning of the big speculators in this market. Even after a sharp break in price, the big specs, HEDGE FUNDS and OTHER LARGE REPORTABLES, still remain overwhelming bullish on this market. Look at the positioning of the LARGE COMMERCIAL interests however, they are barely off an all time high RECORD SHORT POSITION. They expect lower prices, not higher....

This imbalance is not going to last forever. So far, the big specs have been willing to put their money at risk and defend those massive long positions by eagerly buying up dips in price as they are convinced that the worse of the impact of the PED virus is yet to come. Perhaps it is - perhaps it is not. If it is, then the big specs will have been proven to be correct ( much to the chagrin of the small specs who are siding with the commercials ). If it is not however, a mass exodus of speculative longs from this market would unleash a round of price carnage that would be devastating for any hog producer who did not take some measures to mitigate downside risk for his product.

I am especially worried about 4th quarter hogs as they are trading at levels which still seem rather bubbly to me based on the trend in total pork production that I am seeing. Fourth quarter hogs are still trading way above historical norms in price. I do not know if the current trend in these higher hog weights is going to continue the rest of the year - my guess is that it will as long as corn remains cheap. If it does, and if the expansion efforts that USDA noted in that recent Quarterly report continue, and which caught a lot of industry pundits by surprise I might add, we could see total pork production actually EXCEED last year's levels later this year.

I will admit that there are a lot of, "if's" in this analysis, but I note these things as one who has seen a lot of frenzies over the years of my trading career. They can end as suddenly as they begin with the result being a complete erasure of the entire move higher in a sector as the market moves back more toward historical norms.

One more thing and I am done - so far new crop corn is hovering around the $5.00/bushel mark. Beans remain expensive but that is mainly old crop. Soybean carryover should become more comfortable later this year, especially as market demand shifts to S. America. Let's hope that we have a good growing season for our corn and bean crops up here in the Northern Hemisphere this year with the result that we do not see any extreme price rises in feed costs. Hog producers, along with cattle producers I might add, have dealt with high priced grain long enough. They are due for a season of stable yet affordable prices for their feed. If they can get this, they should be profitable for the foreseeable future and that is good news to a group of extremely dedicated and hard working livestock producers.

Those livestock producers who can secure feed coverage and lock in profitable selling prices should do so knowing that they have secured themselves excellent profits and can sleep at night even while the computers wreak havoc in the futures market. They should also understand that they are not speculators but are producers - leave the betting to the specs.