There are more bubbles floating around the earth today than I have noticed in my entire career. Bubbles begin with legitimate economic opportunity but end up crowding out legitmate functions and market signals, resulting in all sorts of distortions and misallocations of resources. They start harmlessly enough where opportunity exists, for where opportunity exists, investment is attracted to capture a return.
A bubble happens when capital overpopulates an opportunity and drives its trading value higher than its fundamental economic value. Since all deviations from reality are at some point rationalized, we can watch at some distance, the natural cycle of a bubble from formation to bursting in a dozen or more on-going markets but some of them we are caught up in more directly.
Depressed Prices Hit Hard As Numbers Rise Ouch! That might be the best way to describe swine economics today. If you are selling hogs on the open market today, and have not locked in any pigs, my best estimate of the losses that you are absorbing range in the neighborhood of $25-$30 a head. Average revenue this month will be around $100-$105 a head, with costs at $125-$135 a head, depending on market weights that you are selling at.
Seeing Red in October This month will not be a good month for pork producer’s balance sheets. In a cost vs. revenue comparison, most systems will lose $10-$15/head during October. Some producers locked in some margins back in August, but most producers did not lock up a large percentage of their hogs with those margin opportunities.
Perhaps the reason more producers didn’t lock in more profits can be explained by reviewing the following December futures chart. You can see the volatility in this month. Many clients that I work with started to hedge for the fourth quarter right around the end of July. As you can see by the chart, it spiked up to $74 in early December. We had a massive amount of margin call money that went out and people stopped hedging because producers struggle with paying margin calls. The market went down and some people hedged a little more. Then the market bounced back up to nearly $70 again in early- to mid-September. Since, it has been a free-fall spiral downward.
Cost of Production Hike Brings Losses – It’s amazing how quickly market conditions can change. Remember back in early August? Cash market prices were in the low to mid $70s and we had every futures month on the board at $70 or above. Plus, the rumor was that China was in the market for buying lots of U.S. pork. Life was good, and it seemed that even though we had more hogs coming to market, prices were going to profitable. Also, at the same time, grain prices were coming down and corn in southern Minnesota was below $3/bu., and it looked like even with the ethanol boom, we were going to have realistic corn prices.
Now at the end of September, the cash hog market is hovering in the high $50s. Corn has jumped from $3/bu. to $3.50/bu. in southern Minnesota, and soybean meal has jumped from around $220/ton to $265/ton.
In just a 60-day period, your cost of production has risen about $8-$9 a head, and your revenue has dropped $30 a head. Needless to say, I do not think September will be a profitable month for the pork industry – and we could be looking at a tough fourth quarter for the industry.
Lots of Pigs – The fact that there are a lot of pigs out there should not be a surprise to anyone in the industry if they have been looking at a couple of things.
The first factor responsible for this trend is the number of weaned pigs and feeder pigs coming down from Canada. I do not see this trend slowing down. The Canadian dollar was on par with the U.S. dollar last week. What many Canadian producers are doing is selling weaned pigs and/or feeder pigs into the United States, retaining ownership and feeding them out. To the Canadian industry, this is a means of self-preservation.
Secondly, performance in most sow herd systems in the United States is excellent. That fact combined with improved production due to the circovirus vaccines being so effective, equates to a lot more pigs being produced and marketed.
I remember writing a column in the beginning of 2007 and stating that death loss on hog farms in the United States was up 1-2%. That equates to a loss of 70,000 sows.
Today I believe that death loss is down at least 2%. Along with the improvement in sow productivity, that equates to the addition of 100,000 more sows to the marketplace, even though we didn’t actually add more sows to the U.S. breeding herd.
The Future for Pork - What does the future hold? If you look at the futures market for pork in 2008, things do not look that bad, and there are still opportunities to lock in profits for next year. If you look at prices on the Chicago Board of Trade through October 2008, the average price is above $72 or a total return of $140 a head on a 200-lb. carcass. Even with the higher feed costs, there is still profit potential for 2008!
I have stated numerous times in this column about locking up profits. It is up to you as a producer to manage that risk. Since 2004, locking up prices on the futures market has proven to be the wrong decision, and you were better off just using the cash market. That still might be true, but also betting that the cash market will always be there is also a hedge in my mind. If you know your costs and can see a margin that you can live with, I think you might sleep better at night than not knowing what lies ahead. I firmly believe in the next two years that marketing – selling your pigs and procuring your feed needs – will separate the best from the rest more than any other factor in the marketplace.
Pass-through is the economic term for how higher (or lower) prices in a chain wind up effecting prices up-chain, say at retail.All outcomes are possible for a price rise such as we have experienced in the corn market due to the government transfer payments for corn producers. Input price increases can lead to complete pass through up chain, more than complete pass through or something less than complete pass through.
Part of the problem in the meat case at retail is there is so much special pricing, loss leader pricing and the like that it is hard to tell exactly what happens for every input price change down the chain.In addition, price changes at retail for products made from agricultural products tend to be very small compared to the change at the production level.This is due in part to all of the value added as the chain progresses (i.e., a few cents worth of wheat in a $4.00 box of wheat breakfast cereal.)Small changes are sometimes unnoticed by consumers as they are lost in the noise of other price changes, the hassles of shopping and plain inattention.