September 18, 2023
Getting economically kicked in the shins is not a lot of fun and we have been in this environment since October of 2022 (averaging right at $30/head losses for the past 11 months, chart attached). The last 11 months have been the most painful in the history of the hog market, more that twice the amalgamated losses of the 2002 or the 2008-09 experience, 50% more than the 2013 downdraw. This has been an unprecedented run of losses and has inflicted severe pain to the pork producer’s bottom line.
The timing on the calendar – coming into the fall – does not bode well for a reversal of this trend in the immediate future, but I do believe we have some signs that the worst may be behind us and better days are ahead. Note that every previous drawdown in this dataset was followed by a good run of profitability and I believe this rhythm will evidence itself once again – it just can’t happen soon enough.
Let’s unbundle three items that I think could turn the tide and allow us a ride back into a profitable scenario.
First, the price of inputs should moderate significantly compared to the past three years. Look no further than the recent USDA corn and soy report. On the surface, they were yawners. Yields came in within the range of pre-report estimates, acres were up on both commodities as largely expected, demand (especially export) remains a burden to the would-be bulls. For corn, we have a projected carryout well over 2 billion bushels and a world scenario that is in excess of 300 million tons and is growing.
In short, we have adequate supplies in the United States and across the world to not create much tension. All things equal, I would expect prices to fade (not collapse) as we approach the spring and the harvest from South America.
The wildcard in this environment – a reluctant seller in the form of the farmer. Unlike the livestock sector, the agronomic portion of agriculture has not seen a setback and the grain producer has never been this wealthy. He had a chance to sell $6 corn for an extended period which is near where the February peg of crop insurance landed. We are now trading at his insurance coverage levels and he has no incentive to do anything to market his crop. Essentially, he has a free put from now until the end of October and as long as he has physical room to tuck away the crop, his incentive to act is approaching zero.
This is a bit of a problem for those of us in animal agriculture; we need the corn availed to the market to feed our inventory. Basis levels right now are wide based on the lack of export interest that I referred to earlier and a river scenario that is running low drafts which increases the cost of transportation. In fact, there was a 10 miles stretch of the Mississippi River just north of Memphis that was closed last week for dredging just to maintain a navigable channel.
Wide carries (Dec-Mar trading at roughly 15 carry) will encourage the corn producer to wait and basis will likely have to do the job of breaking bushels free. This domestic demand market has been with us for the past few years with assorted nuances; we are fortunate this year to have enough production to ease what could have been a bit of sting.
Aside from the dance of basis and timing, we should see a compression in corn prices relative to the past three years and the prospects for a continuation of the same are strong in the next couple of years. This year, we are roughly six bushels off of trendline yield. We were about six bushels off last year. What will happen if we ever get a decent growing year or – perhaps – even favorable conditions?
Future yields hold the promise of tipping the table in the favor of the livestock producer with the genetic package we have in the field.
Second, pork exports look promising. The U.S. is a low-cost market right now and that is the main impetus of the financial pain. The “good” news is that others are hurting even more and the compression in production, especially in Europe, should result in the U.S. being the source of export product.
It is a shallow victory when we are the beneficiary of someone else’s pain, but the math would indicate this transition could be pronounced by the first of the year. It is estimated that EU production could fall in the neighborhood of 10% in the next 12 months. European production is roughly twice that of the U.S. – this is the equivalent of a 20% reduction in U.S. output in terms of volume. We have already experienced a significant bump in exports so far this year (albeit from a compressed volume in 2022) and the future for pork exports out of the US look great.
Third, protein availability in the U.S. will be less in 2024 than what it is in 2023. Poultry is on course to bump up about 700 million pounds. USDA data would suggest that pork production will be up roughly 150 million pounds (I am a bit dubious about that number given the economic strife of our industry, the upcoming September Hogs and Pigs Report should be telling).
These two production increases are offset by more than a projected 1.75 billion pound decline in beef production. That is a staggering value and one where substitution of protein should favor pork. This is not about Dr. Meyer’s cross-elasticity calculations, this is simply a matter of what is available for consumption that will come under significant contraction on the beef front – which should imply higher beef prices, and then we can resume our conversation of how much of a coattail effect can be garnered by pork. The bottom line is the price/availability components are inexorably intertwined and nothing holds still long enough to clearly determine cause and effect in a vacuum. Regardless of whether it is a price or availability prompt, pork should find itself in a more favorable environment in 2024 because of the decrease in beef production. (I will have to go back over the numbers, but I believe 2024 will be the first year in history where this dataset would suggest that poultry production will be higher than the combination of beef and pork).
By nature, I think we are optimists in thinking that the future will be better than the past as we endeavor to make improvements in our operations for the benefit of the next generation. Sometimes hope is all we have to hold onto. While I remain hopeful, I believe we are entering an era where the facts of economics will also find us in a favorable light and that is something we can all celebrate. Comments in this article are market commentary and are not to be construed as market advice. Trading is risky and not suitable for all individuals. Contact Kerns at [email protected].
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