December 2014 – Livestock Market Update
Public Policy Department
Budget & Economic Analysis Team
Feeder Cattle Market Meltdown
This year’s calf market has been, without question, one for the record books. This year’s prices
have been beyond the experience of even the most seasoned cattlemen. To provide a little
perspective, Figure 1 shows weekly average prices on 7-weight steers at Oklahoma City (OKC)
over the past twenty years.
300
250
$/cwt
200
150
100
50
0
Data Source: USDA Agricultural Marketing Service through Livestock Marketing Information Center.
Figure 1. Weekly Average Feeder Steer Price: Oklahoma City, 700-800 pounds, M&L #1
The rise in feeder calf prices has been dramatic, fueled by tight supplies, high downstream
prices, and moderating feed costs. These are strong fundamentals, and they have provided the
foundation for this year’s amazing market performance. But the old adage that “what goes up
must come down” applies not only in physics but also in economics. Within the past two weeks,
feeder cattle prices have come down – hard.
Feeder cattle futures contract prices dropped by the $3 daily limit on Thursday, Dec. 11. They
dropped by that same amount the next day as well, finishing that week with two consecutive
limit-down days. Then last Monday, Feeder Cattle futures fell by the daily limit again. Of
course, by that time, people were starting to take some notice. In fact, people were starting to
panic. On the next two trading days – last Tuesday and Wednesday – Feeder Cattle contracts
spent the entire trading sessions locked limit-down. That means that nobody would trade at the
limit-down price. The market was essentially at a standstill. Anybody with a long position in
that market was stuck in it; there was no way to liquidate a losing position and little way of
knowing how much longer it would last. This is about the worst possible position to be in as a
trader, which is why events like those of last week generate so much angst in the market.
With five days of limit-down moves, the angst was by no means limited to the futures sector.
Cash prices on feeder cattle were sharply lower. This seemed to be particularly true of mid-week
sales, which were occurring at the end of the CME’s 5-day run of limit-down trading. The
market report from West Plains, Missouri’s, Wednesday sale is representative of many locations
around the country: “feeder steers and heifers traded 15.00-20.00 lower with spots 30.00 lower.”
On Wednesday evening, the CME announced that it was expanding the daily trading limit on
feeder cattle contracts from $3 to $4.50, with provisions to move the limit even higher if the
market continued to hit the expanded limit. This seemed a prudent move on the part of the CME,
and in fact would probably have been even more prudent on Monday or Tuesday. The longer a
market locks at the limit, the more uncertainty develops about where prices really should be, the
more desperate traders become to shed losing positions, and the more disruptive the situation
becomes to associated cash markets. In effect, a mechanism designed to provide the kind of
“cooling off” period that can forestall a panic can, in a way, contribute to the panic when things
don’t work right. At least some elements of that dynamic were probably at work last week in the
feeder cattle market. At any rate, CME did finally expand the limits. On Thursday and Friday,
trading was very volatile, but at least trading did take place. In fact, on Friday, all feeder cattle
contracts actually traded up into the new expanded limits.
With the market back in some kind of functioning order, it is pertinent to ask the obvious
question: why? Why did the market decide to come apart and, more specifically, why did it
decide to come apart now? After all, calf prices have been exceedingly high for most of the year.
It’s not like we all just noticed this in the last ten days or so.
The “why now” question is pretty hard to answer. To ask that question is, in effect to ask when
something irrational is going to happen. The fact that it is irrational is what makes it inherently
unpredictable. To be fair, though, over the last few weeks in the cattle market, a better question
may have been to ask when something irrational was going to end; that is, when would calf
prices get back in line with the rest of the market? This, of course, brings us back to the “why”
question: why did the feeder cattle market drop so far? On that point, some rational assessment
is possible.
A good way to look at the relationship between feeder cattle futures prices and other relevant
prices is through the cattle crush. The cattle crush approximates the gross margin from feeding
cattle using futures prices for Live Cattle (LC), Feeder Cattle (FC), and Corn (C). Soybean Meal
can also be included to make the crush margin a bit more realistic, but for our purposes here,
we’ll stick with LC, FC, and C – using the January FC contract since that is currently the nearby
contract.
So, a simple cattle crush using January FC calculates the difference between the value of two
June LC contracts (i.e., 800 cwt) and a combination of one January FC contract (i.e., 500 cwt)
and one March C contract (i.e., 5,000 bushels). On Dec. 4 (a recent high for the January FC
contract), the relevant prices were as follows: June LC = $159.90, January FC = $235.59, and
March C = $3.89 ¾. This results in a crush value of
($159.90 x 800) – {($235.95 x 500) + ($3.89 ¾ x 5,000)} = -$9,542.50.
In other words, the projected gross margin (over calf and corn costs) for feeding cattle – based
solely on futures prices – was a negative $9,500. Obviously, this is not even remotely an
attractive proposition; implying that price relationships among this output (fed cattle) and key
inputs (corn and feeder cattle) were out of whack. Historically, that certainly seems to be the
case. Over the preceding ten years (2004-2013) using prices from the first week of December,
the lowest value for the June LC/January FC/March C crush was around -$5,800 in 2012. Of
course, there are multiple ways for these prices to come back in line (or at least more in line)
with historic norms. Corn or Feeder Cattle prices could fall, Live Cattle prices could climb, or
some combination of these changes could occur. But with corn rallying and live cattle feeling
pressure from a softer wholesale market, the path of least resistance for a correction in these
price relationships was clearly a decline in feeder cattle prices from their record-shattering levels.
Inventory Reports
USDA released the last Cattle on Feed report of the year on Friday. With respect to that report,
the year basically ended not with a bang but a whimper. Key numbers in the report were
essentially right in line with pre-report expectations. Placements in November were down 4
percent, marketings were down 11 percent, and the Dec. 1 on-feed inventory was up 1 percent
compared to a year ago. There is, in this report, additional affirmation of the historically low
cattle inventories. November placements were the second lowest since this series was started in
1996, and November marketings were the lowest over that same period.
On Tuesday, USDA will release the Quarterly Hogs and Pigs report. This newsletter will be
filed before that report is released, but pre-report figures are, of course, floating around now.
The market anticipates an increase in the all hogs and pigs inventory figure of between 1 and 2
percent. With respect to market hogs, inventories of hogs over 120 pounds are expected to be
below year-ago levels while inventories of hogs below 120 pounds are expected to be up by 2 to
4 percent. Farrowing intentions continue to point to robust growth: intentions up almost 4
percent for both the December-February and March-May quarters. The bottom line seems to be
that the market is looking at smaller front-end market hog supplies, but more pigs on the way
though all of 2015. This seems generally consistent with production estimates in the last couple
of supply and demand estimates reports.
Contact: John Anderson, 202-406-3623, [email protected]