Professor Joe doles out first half commodity grades

Professor Joe is viewing first-half 2016 markets from the selfish perspective of a pork producer — corn gets B+, soybean meal: C-, hogs: B, China, A, Mason City, F.

Joseph Kerns

July 11, 2016

7 Min Read
Professor Joe doles out first half commodity grades

The passing of the summer solstice and the turning of the calendar to July means that 2016 is halfway over. Odd. Perhaps it is appropriate to provide a semester grade in the commodity sector for the first six months of the year and provide an outlook for the balance of the year. Professor Joe is viewing markets from the selfish perspective of a pork producer. Here we go.

The first six months
The corn market gets a B+. Aside from a temporary blip to the $4.40 level, corn prices have been moderate, allowing the cost of production for most systems to be within budget and acceptable. A good harvest in 2015 added stocks to the record production of 2014. Basis has remained wide and corn has moved freely to the markets where it is needed with limited distortion. The west has been more plentiful than the east – a scenario that looks to play itself out again this year.

In the big scheme of life, this skew to higher stocks in the west is a good thing as the natural flow of grain is to the south and east. Those in Indiana and Ohio may take exception to this observation; I am viewing this from a macro-industry perspective.

Soybean meal: C-. Fund buying beginning in March of this year disrupted what looked like a lazy soybean meal market that was trading at $280ish for an extended period into a volatile affair. To be sure, production problems in South America coincided with the sharp buying by the commodity funds, propelling us to near $450 on soybean meal before recently settling down. Those who followed the budget or crush model likely had a muted impact from the price run, those in the spot market were forced to reformulate often. If there is a silver lining to the bump in soybean meal values, it may be the availability of alternative ingredients – including distiller’s dried grains with solubles and readily available amino acids.

Hogs: a solid B. We started off the year relatively puny and experiencing losses in the first quarter; we have recently transitioned to summer profits that should allow 2016 to post modest profits for the industry. The same fund buying that caused heartburn in the input markets allowed hog futures to move to higher levels, providing a platform for pork producers to lay off hedges in an active market. This market depth is an important component as we have had experiences in the past where the appearance of favorable hedging values quickly evaporated under the pressure of our selling volume. In this case, the funds held in and were able to buy what we wanted to sell. A wide hog basis has been the fly in the ointment for those marketing animals and not experiencing historical convergence. To me, this is consistent with an artificially (fund buying) propped up market. I would prefer it this way to a sullen futures value and better-than-normal basis.

China: a solid A. The hyperventilation over the prospects of exports to China were a driving factor in the fund ownership of hogs. Actual shipments were a Godsend in what would have otherwise been a very lackluster export pace for the first half of the year. We will need this sponsorship by China to remain in the second half of the year if we want to realize the promise of the futures values availed on the CME. More on that later.

Mason City: a big juicy F. A most unfortunate series of events led to the rejection of a new Prestage packing plant for this community. Well-organized opposition to the project was able to swing the pendulum that was originally thought to be on the “yes” side of the ledger to a “no” vote after a very protracted public battle. Hint: the recent announcement by Prestage of investigating a site in Wright County is indicative that that group has learned from the previous experience and have developed a more palatable approach this time around.

My expectations for the second half of 2016
Corn: A, maybe A+. The USDA has projected record production for the growing crop. (Author’s note: I am writing this in the back seat of the car en route to Wisconsin for the National Pork Industry Conference meeting this week. We are driving through a pounding rain that is requiring us to moderate our pace just to see the road. The system is big and productive, we will have an update from the USDA on Tuesday, a day after this column is published) If I am anywhere close to right, we are going to have a bountiful harvest which will keep a lid on prices for the foreseeable future. Additionally, I suspect the USDA completely biffed on its assessment of corn feeding demand for this year – as evidenced by the large June 30 stocks report – and is really askew with next year’s feeding projection, a whopping 300 million bushels more than this year’s number. The combination of a large crop and moderating domestic demand is not a recipe for higher prices. The wild card is exports – which is somewhat of a toothless tiger at this point. The United States is the market for world corn demand, the problem for would-be bulls is that there is not much depth in the demand scenario for corn. Black Sea wheat is competitive and plentiful.

Soybean meal: B. We are currently experiencing what I have described as the wettest drought in history. Crop conditions remain favorable and anything absent of a disaster in August should bring some relief to prices relative to today’s values. We are not out of the woods quite yet. In fact, our late-summer commitments for bean exports could still provide some fireworks for the late-summer, spring of 2017 futures are already pricing good Brazilian production and are providing a $30 per ton discount to nearby numbers.

Hogs: a shaky B. I admit my trepidation for the last half of the year pricing in the hog markets. We recently ran futures (again, thank you, funds) up in the summer months, the August contract traded briefly above $90 before fading $10-plus. The back months have largely not participated in the big run nor the fade. We are going to have a busload of beef on the market in the last half of 2016, and keeping exports at a robust pace is going to be necessary to realize the values available on the board today. After the recent decline in corn futures to life-of-contract lows, our forward crush model briefly showed profits for every month (albeit, skinny late in the fourth quarter) for the Midwestern producer. This is a factor that I do not want to ignore. Breaking even or a small loss in the fourth quarter of 2016 and the first quarter of 2017 may not be the worst idea in the world if it provides you the opportunity for participation in better markets, the most obvious inflection point is the startup of the Coldwater, Mich., and Sioux City, Iowa, facilities in the summer of 2017.

So what is a guy to do? Find a value on corn that works for your operation, own the cash, buy puts under the market just in case we get a big wash. Important: I am not bullish corn, I just want to recognize its value to the ration and what it means to a pork producer’s profitability. The soy complex is, well, more complex. The fortunate part is the continued availability of protein alternatives to the diet, trading soy is more of a waltz than a walk. I think you have to own it on breaks with puts owned for the just-in-case scenario. Similar gig with hogs – protection in the fourth quarter of 2016 and the first quarter of 2017 in conjunction with option ownership (calls) in the event the China impact is greater than I am giving it credit.

Mason City still gets an F.

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

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