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Lean hog futures in a holding pattern

At some point later this year, likely starting in late summer, tariff or no tariff, the Chinese will be forced to dramatically increase pork imports from the U.S. They simply won’t have any choice.

Looking at the summer lean hog futures charts you’d never know that African swine fever was wiping out huge numbers of pigs in Asia. The futures market has lost all urgency with regard to the situation in China. Someday this will change.

While we’ve never seen a confirmation statement issued by the Mexican government, their 20% tariff on U.S. pork should have been rescinded when the Trump administration eliminated the tariffs on steel and aluminum imposed against Mexico and Canada. This is a very positive development for the U.S. pork market. Mexico is our largest traditional buyer of pork. I say traditional because we fully expect China to be the largest buyer this year and likely for the next several years.

The ASF situation in China and Vietnam continues to worsen. Don’t let the poor action in the U.S. futures market fool you into thinking otherwise. My sources, multiple sources, suggest the devastation in China is nearly beyond comprehension. The official Chinese data indicates that the breeding herd is down 22% as of the end of April compared to the same period last year. They lost 1% during April. The disease continues to spread and massive culling of animals continues to occur. This is occurring under the radar and is certainly not being reported by the government. The Chinese government will likely never reveal the actual losses which have occurred. Private companies that are doing business in China report far greater losses than currently being reported by the Chinese government and by the USDA. Losses of pigs range from 150 million to 200 million and losses in terms of breeding stock range from 30% loss to as high as 50%. Before ASF struck we estimate that China had about 40 million sows. Thus, it appears likely they’ve lost to disease and/or culling anywhere from 8 million to as many as 20 million sows. For comparison, the U.S. breeding herd currently stands at 6.4 million.

Being conservative, if China has lost 25% to 35% of their herd, we’re talking about a loss equaling 14% of the global supply of pork. This will, in turn, create a 16 million metric ton production deficit. A deficit of this size is double the normal pork trade. In other words, if all pork exports in the world went solely to China and nowhere else, it would only represent 8.3 million metric tons. So you can see why the numbers involved are simply difficult to comprehend. The displacement in the world protein markets is going to be unprecedented. Indeed, look for the price of all meat proteins to rise in the months ahead. China is a virtual giant in terms of pork production/consumption. Put another way, total world pork exports (8.3 million metric tons) represents only 16% of total Chinese pork production (2018 production = 54.15 million metric tons).

The situation in Vietnam is grim. Recent reports indicated over 2,100 new outbreaks have been reported. Reports of new outbreaks went silent as of March 24 until the recent admission that ASF continues to spread in an out-of-control fashion. Current estimates are calling for a 20% loss of the hog herd which equates to about 6 million pigs. Vietnam is the sixth largest pork-producing country in the world.

Going back to China and the loss of breeding stock, one must realize and address what I call the “magnifier effect.”  Indeed, the inability to produce pork down the road will be amplified by the loss of breeding stock. For example, if China has lost 8 million sows, given two litters per year and seven pigs per litter, we’re talking about a loss in production for next year of 112 million pigs. We will likely slaughter about 130 million pigs this year. So we’re talking a loss in productive ability equaling 86% of U.S. production.

While the lack of bullish enthusiasm in the U.S. lean hog futures market is hard to believe in the face of such a long term bullish fundamental development, the bottom line is that pork export trends going to China are very positive. Indeed, first quarter European Union pork exports to China have soared, recently reported up 26% from the first quarter of last year. This is a huge year-on-year increase. Cash hog prices in France have increased 24% from early March. For comparison, total first quarter U.S. pork exports were down 6.4%. So the current tariff situation (China has a 50% tariff on U.S. pork and until last week Mexico had a 20% tariff on U.S. pork) is definitely hampering U.S. pork exports.

A closer look at the data, however, indicates that perhaps the 20% Mexican tariff on U.S. pork is hurting U.S. producers more than the 50% Chinese tariff. Chinese pork imports from August of 2018 to March shows the following trends: Canada pork exports to China during this period are up 128%, Spain up 89%, Germany up 75%, The Netherlands up 150%, Denmark up 132%, France up 102% and the U.S. up 187%. The recent removal of the Mexican tariff on U.S. pork combined with expected increases in Chinese imports should eventually drive hog prices higher and likely sharply higher.

At some point later this year, likely starting in late summer, tariff or no tariff, the Chinese will be forced to dramatically increase pork imports from the U.S. They simply won’t have any choice. The EU cannot supply all of their needs. Simply put, at some point the U.S. futures market will realize and come to terms with the fact that there’s not going to be enough pork in the world.

To date the Chinese have booked 195,000 MT of U.S. pork and to date they taken shipment of 73,000 MT leaving 122,000 MT of pork sold but not shipped. With 32 weeks left in the calendar year, we’ll have to ship 3,800 MT each week to meet these sales. Recently the offtake to China has been around 4,000 MT. Assuming they continue to purchase U.S. pork shipments will have to begin increasing.

Many in the trade believe the Chinese will shy away from pork (pork is the staple in both China and Vietnam) and move toward other protein sources. The most logical choice would be chicken. Keep in mind that currently there’s a longstanding ban in China on U.S. poultry imports due to bird flu from 2003. Brazil, Argentina, Chile, Thailand and Poland have all experienced sharp increases in poultry exports to China. Specifically, during the August 2018 to March timeframe, poultry exports to China show the following trends; Brazil up 11%, Argentina up 39%, Chile up 83%, Thailand up 381% and Poland up over 8,000%. Keep in mind that as the traditional buyers of poultry from these countries get squeezed out, they’ll likely come to the U.S. for their poultry needs. My industry sources are indicating that China does not have a quality breeding herd to allow for a rapid expansion of broiler production within the country. Beef is too expensive to import in huge quantities.

The lethargic action in lean hog futures will likely continue until large shipments begin to dramatically tighten the product channels. At this point cutout values will soar and the cash hog market will turn very strong. Late this summer is the timeframe in which this situation may begin to unfold. We believe the Chinese are currently pulling large amounts of pork out of frozen storage. Starting in July government rules stipulate that all pork pulled out of storage will have to be tested for ASF. If there’s a positive test, the pork can’t be consumed. So they’re aggressively pulling out of storage ahead of July 1st. We estimate they have the ability to store only five to not more than nine weeks’ worth of consumption in frozen storage.

Trading strategies will include the attempt to lock in a price floor against the August hogs at $80.00. On a sharp rally in futures we hope to secure the August lean hog $80.00 puts for as close to $1.00 as possible, locking in a net floor of $79.00/CWT. The August puts will also provide a high measure of protection in the event of an outbreak of ASF in the U.S. Such protection would be in place until expiration on August 14. After that date, additional protection will have to be secured through the purchase of October puts. For our speculative traders we’ll be looking at buying October calls/selling puts on any weakness into the mid-June timeframe.

Source: Dennis Smith, who is solely responsible for the information provided, and wholly owns the information. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset.
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