Key reversal was meaningful after all

Two fundamental developments gripping the market are the severe lockdown in China due to COVID-19 and fear of recession in the United States.

Dennis W. Smith

May 2, 2022

5 Min Read
Getty Images U.S. China dollars.jpg
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Last month when I posted my article June hog futures had just completed a key reversal in the wake of the bullish USDA Quarterly Hogs and Pigs report. I noted this but also indicated the market had been down for three consecutive sessions and that might be the extent of the downward correction.

WRONG. June futures were lower one more session (four sessions including the key reversal day), then they chopped sideways for four sessions and then rallied sharply, moving from $114 to just above $122.

Indeed, it appeared the uptrend was ready to resume in force. Then the wheels came off. Prices have declined from $122 to $106 in quick fashion with two fundamental developments gripping the market and encouraging aggressive selling. These two developments are the severe lockdown in China due to COVID-19 and fear of recession in the United States.

The fear recession was somewhat predictable but the Chinese lockdown of 27 cities impacting the lives of some 165 million citizens was totally unpredictable. So, the bullish story in hogs is still simmering but for now the fire has been extinguished. Remember, where there's smoke there's fire and I still smell smoke.

This market, while deeply disappointing, is not over. Clearly, the technical trade is in charge now with a near textbook head and shoulders top formation. The formation, I'm told, has a downside measurement target of $98. There's support (full Fibonacci retracement) at 10570, just below the settlement of $106.40 on Friday, April 29. I have my doubts that the final target of $98 will be achieved.

The outcome of the Chinese COVID lockdown is highly unpredictable. Mastering the Omicron virus appears to be an impossibility. Will the Chinese authorities change strategies and open and simply let the virus run its course. If they keep the lockdown in place for say another six weeks, then economic pain across the world can be expected. The government is walking a tightrope here. Huge numbers of Chinese citizens are becoming very unhappy, restless and in many cases hungry. The Chinese government fears greatly just this type of situation. Widespread unrest across the country can threaten their form of government. Whenever the lockdown ends, expect widespread and dramatic stimulus measures with enormous pent-up demand to literally explode. I certainly don’t want to be short lean hog futures when this develops.

The second fundamental development, fear of U.S. recession, is also most difficult to predict and manage. I've read opinions from top analysts and economists with some indicating recession is a lock and others saying recession, this year, is very unlikely. GDP growth was down in the first quarter. The definition of recession is two consecutive quarters of negative growth. It is worth noting, however, that historically pork demand is not hit nearly as hard as beef demand during a recession. It's also worth noting that lean hog futures and live cattle futures have not participated in the huge upswing in commodity prices on the latest inflation binge.

With feed prices expected to remain elevated for possibly another year and maybe as long as three years, one should anticipate overall meat production to decline and meat prices to rise. It will take a dramatic drop off in demand to stifle the livestock markets over the next couple of years, in my opinion. Without a sharp shift in the demand curve for red meat, hog and cattle prices can be expected to move higher over the next couple of years.

Don't forget that the March Hogs and Pigs report, regardless of the recent price action, is long term bullish. Certainly, the last thirty days have done nothing to foster any changes in the current contraction. Lean hog futures have tumbled while corn and soybean meal prices have moved sharply higher. One of the major problems with the elevated price of corn is the fact that wheat prices are also highly elevated. There is simply no cheap substitute available.

In addition, we're talking about elevated global feed prices. This is not just a U.S. problem but a problem facing every hog producer in the world. Be aware that hog and pork prices are currently soaring in the European Union in the wake of their deep contraction.

The Chinese recently confirmed that their herd has contracted by over 26 million head in the first quarter. Hog prices in China have edged upward and away from the lows but prices remain well below cost of production. We believe that Chinese hog producers have been liquidating pigs for more than eight months. I still believe that by mid-summer China may be forced to enter the U.S. pork market for substantial quantities as their production drops off.

Finally, returning back to the June hog chart, I stated earlier that hogs are a big market. Reflecting upon that statement, I decided to look at the daily chart and pencil out Fibonacci retracements for the entire move. The bottom occurred in the middle of September (8700) and the high in late March (12730). A full, .618 retracement would occur at $102.35. I also noticed that there's a gap on the chart from a higher open on Jan. 20. A trade to $101.95 would fill this gap. Perhaps a trade to $102 is where this market will finally exhaust the selling pressure.

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. The opinions of this writer are not necessarily those of Farm Progress/Informa.

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