So let’s play around a bit with this variation stuff and see how the future cost of production might look for hogs if we forecast it by first forecasting corn and soybean meal prices and then putting those forecasts into a cost of production model to generate a forecast for future carcass prices.
This hog cost forecast was generated assuming that corn would average about $3.50/bushel and that soybean meal would be about $250/ton on average. Under those circumstances and some stuff I will share in a minute, the average hog cost of production for a 270lb animal would be about $62.50/cwt on a carcass basis. However, by using the variances and the correlation between the input prices in the forecast model, we can create a forecast not only of the average price but the range over which it is likely to wander and the probability it will reach any one price in the range.
We can first note that corn and soybean meal prices do not follow a normal distribution. The upside tail is a lot longer than the downside tail. This means that extreme prices, when they happen (as compared to the mean price) tend go a lot higher than the expected range below the mean. This happens when droughts or other events like ending stocks compared to use etc. cause big spikes.In messing around with this forecast, I have assumed the future variation in corn and soybean meal prices will be similar to what it has been in the last 10 years. In addition, for this simulation, I have correlated the soybean meal prices and the corn prices in a fashion similar to their actual correlation over that same period. Corn and soybean meal prices tend to move together over time. Since 1990, bean meal and corn have a positive correlation a bit over 0.5. This suggests that as corn price increases, it is usually associated with an increase in soybean meal prices but not always.
Noting the expected variance, my forecast suggests in the extreme, hog costs could be as high as $80/cwt on very rare occasions and as low as the low $50s. About 95% of the time, the model suggests costs will be below $70/cwt and above about $56/cwt. Since I never forecast hog prices, I have come dangerously close to violating that rule in this exercise. Don't even think of asking me to do that.
