Pork complex poised to seriously challenge demand

Record large pork production was expected, but poultry production is also record large and beef production is rising compared to last year. It is likely per capita meat production will reach a record at some point soon.

Dennis Smith

September 26, 2016

4 Min Read
Pork complex poised to seriously challenge demand
<p>Predicted expansion in pork production is becoming a reality, and with it pressure on this fall&rsquo;s slaughter capacity.</p>

Eighteen years ago hog prices collapsed when packer slaughter capacity was challenged and market hogs had to be slotted. It became a buyers-market. Packers simply dictated what price they would give for hogs. The cash market dropped to 8 cents a pound for a brief period before bottoming out. Packer slaughter capacity is possibly going to be challenged this fall.

I’m not predicting there’s going to be anything close to the debacle that occurred in the fall of 1998. We have been concerned enough, however, to purchase deep out of the money puts to hold in the event of tremendous price weakness. We own the October hog 52, 50, 48 and 45 puts. We consider it highly likely that the 52 and 50s will come into play into expiration. Expiration of October hog options occurs on Oct. 14. Because hogs are an indexed commodity, futures and options expire on the same day. The expiration price is dictated by the CME lean hog index. The latest index stands at $59.88.

We’ve known for months that 2016 would experience record large pork production, and these predictions are proving to be accurate. In addition to record large tonnage in pork, poultry production is record large and beef production, while not record large, is indeed rising compared to last year. It is highly likely that per capita meat production will reach a record at some point soon. This has not been experienced since 2007. Weekly hog slaughter continues to rise earlier than expected this fall. The kill for the week ending Sept. 24 at 2.466 million, was up by nearly 5% from the previous week and up 8% compared to the year-ago actual kill. This kill also represents the third largest weekly kill on record, ever! If slaughter rates of this magnitude persist for very long, severe downward price adjustments will likely occur.

When hog supplies are out of balance with demand, typically pork packer processing margins improve rather dramatically. Basically, the leverage resides with the packer in times of supply excess. They crack the cash hog market lower in larger proportion compared to weakness in the product. This allows margins to improve. Currently pork packer processing margins are not only profitable but they reside at record levels. This too, is a warning sign that lower prices are likely on the horizon.

We certainly can’t describe pork demand as poor but demand does not appear to be strong enough or improving fast enough, to absorb such large production. The latest export data was very disappointing from the view point that rising exports will help absorb record large production. July pork exports were up less than 2% compared to July of 2015. Trade with our largest customer during July, Mexico, was off by 10%. Exports to Japan, our second-largest customer was down 6%. Pork trade to China and Hong Kong were higher and help with the overall trade picture, but increased pork trade with China just never seems to meet expectations.

It’s my opinion this has consistently been the case ever since the Chinese purchased Smithfield. Most believed that when China purchased Smithfield that pork exports to China would surge. Frankly, it has not worked out that way. Lower product prices are going to be necessary in the weeks ahead to clear product through both the domestic and export channels.

If your enterprise needs help in dealing with this possible extreme situation, we can map out a specific plan. Simply contact us. The good news is the fact that several new processing plants are under construction, meaning that this fall will likely be the last crisis of this sort, at least for several years.

Finally, hog producers need to be aware that the USDA will issue their monthly hog and pig report on Sept. 30. Our chief concern is that a fairly stable breeding herd, in the face of continued improved efficiencies, will translate into expanded production. If the report should happen to show expanding breeding numbers, in tandem with improved efficiencies, the report could prove to be extremely negative.

On a broad scale, it appears “the world” is also expanding pork production. We believe that production is currently expanding in Brazil, China and Russia. The only major pork producer that’s likely not in expansion mode appears to be the European Union.

About the Author(s)

Dennis Smith

Archer Financial Services Inc.

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