Son of a gun the hogs have displayed an impressive summer rally driven by rising fresh belly prices. The belly drawdown during June was impressive, down 9%. This demand appears to have been a combination of stockpiling for Prop 12 and the demand for fresh exceeding the production of fresh.

The Prop 12 situation remains shrouded in uncertainty. The demand for fresh bellies surging beyond production was unexpected by most in the trade. All winter and early spring belly demand had been very poor, mostly because retailers had refused to lower prices.

However, this all changed at the onset of summer. Retailers suddenly started lowering bacon prices presumably to lure consumers into the outlet. The consumer response was impressive with demand surging just as production started dropping. The result was an impressive rally in fresh belly prices, moving higher for 19 consecutive weeks. This, in tandem with rising carcass values and higher cash lifted summer lean hog futures beyond most expectations.

After months of losses, there has been a window of profitability in the industry. Recently there has been growing evidence that the surge in fresh belly prices may be nearly complete.

Production is beginning to increase with slaughter rates starting to run higher than year ago levels. Hog weights have also increased with recent data showing average live weights running slightly heavier than this time last year. So, the one/two combination is pushing additional pork into the pipeline as summertime belly demand approaches a peak. In addition, sow slaughter since June 1 is running 10% higher than last year.

Indeed, the industry is responding to months of losses by culling the breeding herd. Earlier in the summer rumors swept the trade surrounding a large liquidation underway at Smithfield, the largest pork producer in the country. Seaboard just announced a $104 million loss in their pork division in their second fiscal quarter.

The lean hog futures market is not optimistic, at least not for the rest of this year. October futures are $18 discount to August futures. December futures are $7.70 under the October contract. Basically, futures are sending the message that industry-wide losses will resume this fall and remain in place for the entire fourth quarter.

The outlook for the hog carcass is not any better. The current hog carcass is valued at $113.69 but the August carcass contract is 420 under the current value. The October carcass contract is $16.40 under the August contract. Seasonal lows are due at the end of August with a major seasonal low due in early November. A selloff into the seasonal low timing is going to put huge pressure on the industry. Indeed, culling of the herd is expected to continue.

One bright spot is that it appears the Corn Belt will produce a successful corn crop this year, one that approaches a record. Lower to sharply lower corn prices are desperately needed to help lower breakeven cost of production.

I would consider a settlement in October futures below $81.40 a bearish sign of lower prices to come. This would confirm that a new downtrend has begun. Depending upon a producer's cost of production, aggressive hedging below the cost of production is not advised. Partial hedging perhaps, aggressive hedging no. In a situation like this we prefer option window strategies designed to provide a measure of protection but also designed to allow one to participate in a measured rally, should one occur. For example, during the week ending Aug. 4, we were actively establishing a bearish three-way risk reversal. Specifically, we were buying the October $82 puts/selling the $70 puts and selling the $92 calls, paying less than 100 points in premium. If you'd like to discuss the merits of such a strategy, please contact my team.

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