January 18, 2021
Unlike football, basketball, or most other sports, baseball is an interesting game because it has no clock. The pace is generally deliberate, with a lot of strategy and analytics playing out behind the scenes. Some of the happenings in pork production are similar.
The Chicago Mercantile Exchange has gone wild lately on the grain side, and it is easy to think that you missed the hanging curveball of $3.50/bu. corn when we are now trading above $5.00/bu. However, I think that this may be a time to reflect on strategy for the rest of the game since we are unable to erase what happened in the early innings. We have a game to play, and we need to make some adjustments.
The recent USDA report provided a boost to a grain market that was already on a roll. Following the report’s reduction in corn yield, those futures went limit up. The bean carryout, on the other hand, was reduced to the second-lowest level ever (expressed as a percentage of carryout/use ratio, only 2013-2014 was tighter). All of this was a recipe for discomfort for the end-use community. Let’s unfold this one just a bit.
First, we are not going to run out of corn this year. Carryout numbers were compressed to levels that might force us to get creative with our sourcing, but we are not going to go without. You may not like the price you have to pay, especially if South American weather does not cooperate (more on that later). Cash corn is flowing freely right now, with a good portion of this being driven by margin call requirements that are causing the short hedger some pain and forcing grain into the market. Basis levels are widening with the product on the market. Some are using this opportunity of weak basis and a carry in the corn board to secure physical supply. Basis probably will not get away from us too bad as the CME is an export-based settlement tool and demand at the Gulf remains brisk. The price in Chicago should be reflective of those economics. The corn inventory picture will give you an idea of where the grain is stored relative to your location and a feel for the year-over-year change in availability.
Ethanol margins have come under pressure with the value of the DDGS as one of the few bright spots for that industry (See below chart). This one bears watching as we approach spring and a steam-intense process can afford downtime. Any reduction in crude oil price could spell some massive downtime into the summer. This a double-edged sword as lower ethanol grind means more corn supply for the feeder but also that availability of a protein substitute for soybean meal is lower.
The soybean situation is the one that causes me the most concern. I have previously indicated that we have the chance of getting tight later in the year. This report exposed that fear, with an exclamation point. The USDA reduced the carryout projections generally in line with trade expectations, which confirmed the view that it is vitally important that the U.S. grows a sufficient crop next year to avoid a repeat of beans-in-the-teens once we get to the fall harvest. Pork producers have seen this one play out before in 2013-2014, as I referenced earlier. That summer, cash soybean meal traded in excess of $600/ton as we tried to pry the last of the beans from the farmer and move them into their desired position. The below map depicts the location of beans from the December stock report. Note that the east side of the Mississippi River is generally in better shape relative to last year as compared to the west. It is oddly fortunate that we are rallying futures in the winter months to provide the proper economic signal to the farmer rather than waiting until we get to the summer when cropping decisions are in the rearview mirror. This is critically important to the southern portion of the growing region where those that are able to harvest beans in August are looking at nearly $2/bu. incentive to get beans to market rather than waiting until October. So, what is a pork producer to do? First, an evaluation of your diets using current values is vitally important. Too often, we formulate using our cost basis which tends to distort the proper economic decision. If you own $350 soybean meal in a $500 market, use the replacement value in formulation to stretch your good ownership over more time. There are feed additives vended by the nutritional providers that may also help you stretch your soybean meal usage. Second, visit with the processor regarding the prospects of soybean meal basis for the summer. You are more than likely to get a big “no offer” tossed your direction, the easy decision is gone. Third, if you have beans or access to beans, you have a barter to secure meal. Do not sell your inventory without a reciprocating meal purchase. Crush margins for the processor have come under pressure, so this picture will not be pretty from a basis standpoint, your animal performance metrics likely justify the behavior.
The same USDA report that sent the market higher because of our balance sheet also gave us an update of South America. There has been a lot written about the impact of La Niña and its impact to potentially compromise yields. There has not been a lot of evidence yet that this has been the case. Here is the paradox. South America can, and probably will, grow a record crop, and we can still have tight conditions this summer in the United States. The U.S. has shipped twice as many beans to foreign consumers compared to year-ago levels, with China up 270% from an admittedly low level of 2019. We have supplied the world so far and may have depleted supplies to a point that causes some discomfort in the summer months here at home.
The pork sector has been wallowing in a relatively narrow range on the front end of the market, with the cutout seemingly stuck, the February contract in a defined trading pattern, weights heavy, harvest numbers record large. Amidst all of this quagmire, the summer months are making new life-of-contract highs. What is going on here? In my opinion, it is perfectly logical and indicitive of where things are heading. The whisper of the market is telling us that better times for the pork producer are on the horizon. Between the packing community beginning to show their hand with some interesting cash bids, the prevelence of some nasty PRRS strains impacting our production, and the aforementioned input cost (along with the antectodal space available), all point to a compression of hog supply sometime soon. I am uncertain whether this sceanario will save the February contract, as the esteemed economist Dr. Steve Meyer will often remind me that February is a tough time for pork demand. But, the feel of the market certainly has a contrast between our current experience and what we can expect down the road.
If this were a baseball game, the home team may not have the lead in the early innings, but the opposing pitcher is beginning to show signs of fatigue and we have the heart of our batting order on queue. I like our chances to make some noise with profits and wish to be strategic in how we play the game.
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. For more information, contact Joseph Kerns.
Source: Joseph Kerns, 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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