Time to prepare hog hedging strategies

Dennis Smith

February 22, 2016

4 Min Read
Market hogs
Getty Image/Scott Olson

Take a look at the commodity world and you’ll notice that nearly all commodities are in protracted, if not steep, down trends. These include crude oil, coffee, sugar, cocoa, cotton, corn, soybeans, wheat, natural gas, copper and live cattle. Recent developments have witnessed aggressive buying in gold and silver, lifting these markets into uptrends which may or may not last.

Hogs are the lone exception. Lean hogs have been in an impressive uptrend since the middle of last November.

Despite record large production last year and projections for record production again this year, cheaply priced pork has attracted renewed demand. Of course the function of low prices is to stimulate demand, thus, the old saying; “low prices will eventually cure low prices.” Inexpensive pork prices have attracted increased levels of demand both domestically and in the ever-important export market.

Recent reports by Urner Barry confirm that the value of the hog carcass in January moved above year-ago values. However, current carcass prices are hovering about 10% below the five-year average for hog carcasses at this time of year. Pork exports during 2015 were up nearly 2% from 2014. More importantly the export market was picking up steam late in the year, mostly in direct response to lower prices offered to our export customers. Recent data just released confirmed that pork exports during December were up 9% compared to December of 2014. Pork is much cheaper than beef which remains historically high.

Important season nearing

USDA projections indicate that hog slaughter numbers this year will exceed last year by a slim margin, perhaps less than 1%. So, slightly higher production when faced with substantially better demand has seemingly bottomed hog prices. The question to ponder is; how long will the uptrend remain intact?

Seasonality in hog production causes the summer hog futures to trade premium to the winter months. Currently the June hog contract is trading $10 per hundredweight over the April hogs. Hog numbers tend to taper off in the summer months, resulting in reduced production and rising cash hog prices.

We’re currently approaching one of the most important seasonal timeframes (in lean hog futures) of the entire year. Typically it’s normal for lean hog futures to top out from early March to early May. The seasonality seems to be moving forward each year so that the prime seasonal peak period can be expected in early March. With summer hog futures trading at a substantial premium to the cash, and with nearly all other commodities locked into down trends, this could be a really important year to lock-in prices via short futures hedges, options and/or option windows or forward contracts.

Tight butcher hog numbers?

In addition to improving demand for cheaply priced pork, there is another potentially bullish hog fundamental to consider and/or be aware of. I’m referring to the possibility that butcher hog numbers during the summer season could run tighter than expected. Our clients and other sources continue to suggest that porcine reproductive and respiratory syndrome represents a more serious problem than realized in hog production this winter.

Recently feeder pig prices have rallied sharply providing some confirmation of this talk. If butcher hog supplies drop off more than expected this spring, in tandem with improving demand for U.S. pork, an impressive rally in summer hog futures could develop. Given the fact that nearly all commodities remain mired in down trends and in the face of global economic uncertainty, utilizing a sharp rally in lean hog futures this spring could make a major difference in a producer’s bottom line. We will be utilizing a combination of short futures, long puts and option risk reversals, or what we refer to as option window strategies to lock-in profitable prices for our producer clients in the event of a strong seasonal rally.

Lastly, it should be noted that producers will need to pay close attention to possible problems with hog numbers this coming fall. Keeping in mind that production is forecast to be record large this year, slaughter capacity constraints could be challenged for a few weeks in the peak fall slaughter season. The good news is that next year two new slaughter facilities will come online, providing relief from this concern. The next quarterly hog and pig report, according to my commodity calendar, is scheduled for release on March 25, which is Good Friday. Typically the exchanges are closed on Good Friday. Regardless, this report should shed some light on the winter pig crop and thus on butcher hog supplies projected for the summer months.

Dennis Smith is a full service broker with 30 years’experience in the industry. Smith and his partner work extensively with livestock and grain producers and assist in developing and executing hedging strategies. Smith publishes his evening livestock wire which is widely followed and highly respected in the industry. A free 30-day trial is available by emailing [email protected].

About the Author(s)

Dennis Smith

Archer Financial Services Inc.

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