Just 70 days ago, I was looking at the the lean hogs December contract feeling more than anxious about how producers would survive under current market conditions. I was in continued discussions with producers on what the best strategy would be for their operation.
The December contract was in the low-$50 range and June was only in the low-$70 range. This reassures me that no person can out guess the market. Whatever your strategy was then, you adjust with the new information you have in front of you and continue with a sound strategy to hedge profits when they meet your targets. Easier said than done, but don't get caught looking back and second guessing your decision. Remember, it was only a couple of months ago most producers were looking to survive. As a reminder, look at the December lean hog contract chart below.
What has changed? In the past 70 days, we have added Coronavirus Food Assistance Program 2 on top of CFAP1 and the Paycheck Protection Program. This has been a tremendous financial boost to smaller producers especially if they also had cropping operations. Unfortunately, with the USDA cap of $750,000 per family, this was minimal help for any operation over 2,500 sows.
In addition, Germany recently announced they found African swine fever in wild boars along their border with Poland. This started a wave of countries shutting off German pork imports. With the United States being one of the beneficiaries, cutout has been on an upward trajectory ever since. You only have to go back to Aug. 5 to find cutout below $70.
Looking at the futures for the next 12 months there is some opportunity, but when do you start locking in those profits? Unfortunately, the level of profitability we have today has diminished the past couple of days. However, with cutout remaining strong I would expect the deferred contracts to bring more opportunity in the near future. Now it is even more important than ever to know your actual cost of production, especially when we are looking at tight margins for 2021. Without knowing your cost of production, it will be almost impossible to execute your business plan. Be sure to have a cash flow model that you can trust. Build one or find a consultant who has one and hire them.
I have been on the record previously stating that we were backed up on hogs. Slaughter numbers over the past couple of months have proven me wrong. I had an educated guess on how many pigs were culled from the U.S. inventories, but that alone did not provide the decrease of numbers to get us where we are at today.
Looking at last week's pigs harvested numbers, we are at year-ago levels. We either had more pigs culled from inventories or we sold vastly larger quantities to secondary markets. Whatever happened, we were able to reduce the numbers. Does this mean we have reduced the 5% of production anticipated for 2020? Not necessarily. I still believe there was a conscious effort by most producers to reduce their inventories. We saw it through reduced breed targets, more selective culling in farrowing, nursery and finish inventories and getting as current as possible with marketing over the past 60 days.
We have seen some sow liquidation, but not at the level to reduce the sow herd by 5%. I would fully expect producers to do what they do best, raise pigs and improve production. We are looking at $90-plus cutout in December.
I would expect every producer out there today is doing everything possible to not only get back to production levels in their operations pre-COVID, but striving to exceed those numbers. This is exactly why you will need to have a marketing strategy in place that allows you to lock-in profits when they do hit your targets.
Steve Malakowsky is a vice president Swine Lending Specialist, with over 23 years of experience at Compeer. For more insights from Malakowsky and the Compeer Swine Team, visit Compeer.com.