By Pat Garrity, Archer Financial Services Inc.
Hog futures have taken a slide recently, but will it last? After an impressive $7 rally in two weeks, the October contract fell over $8 in half the time. The contract is currently testing the April low of $62.425 but has held so far.
The freshly expired August contract finished at a new contract high but since the August went off the board, the October has struggled to hold its own. The October contract still has six weeks until expiration and many variables will have an impact on its price. There are currently some knowns and some unknowns in the hog market that can keep prices retreating or spring a recovery.
One thing we know is that demand for pork is strong and doesn’t look like it will slow down anytime soon. The strongest demand has been for the pork belly which is used to make bacon. Years ago bacon and pork bellies had a seasonality to prices. During the summer when BLTs are popular the prices would surge with demand but in the winter the demand would weaken and so would the price. In today’s age, bacon demand is consistent and retailers are featuring it in many places. You can find bacon on burgers, sandwiches, salads, among other items. The bacon demand had helped pork belly prices surge in the last month before recently faltering quickly. The pork cutout gained with the surge in belly prices as it comprised about 30% of the value at one point and was the main catalyst for the pork cutout value soaring. However, last week alone saw the value of the pork belly drop $27. If the belly prices start to find a bottom and start a recovery as quick as the decline, the cutout value will gain and help cash hog prices recover.
The pork belly supply was drawn down again this month as evident in the latest USDA Cold Storage Report that was issued last week. The report showed pork belly stocks down 21% from last month and 65% from last year. Seasonally it is common for the pork belly supply to decrease at this time before gaining into the fall. However, this year we could see less of a recovery in the build of belly stocks as demand is so strong.
One unknown currently hanging over the market is the North American Free Trade Agreement situation. The uncertainty regarding whether or not the United States will pull out of the agreement is a key factor to watch. Mexico has been a vital importer of our pork, especially hams. They have been a consistent player in the weekly export totals as China remains disinterested. If President Trump decides to leave the agreement or tries to alter it in any way it could spell trouble for hog exports.
Last week net sales and exports were strong. Net sales of hogs at 20,100 metric tons were a 9% increase over the four-week average, and the exports of 18,100 metric tons were up 3%. The primary destination of the exports continued to be Mexico as they were shown to receive 7,900 metric tons. With the dollar continuing to slowly grind lower, it is a promising sign for the export market and should keep the demand for U.S. pork firm.
The supply has been well-documented and record large production has been ongoing for the past two years. The kills have been large and there is currently no shortage of hogs. It will be interesting to see when the two new plants are established what that will do to cash prices. One would think that added competition would help prices in the face of strong demand. We think that even with record production, the strong demand will be able to absorb it and the two new additions will only help going forward. They can only kill the hogs that are available as they will not be manufacturing hogs.
The strategy we have used of late is to purchase October hog calls. With six weeks remaining you are buying time for this market to forge a base at current levels before springing higher. We think the incredible demand will remain in the picture and the bellies could lead the cutout back higher. Buying call options allows you to know your risk as it is only the premium you pay up front. There is no margin assigned to holding a call option. The cash hog index, last quoted at $78.23, remains well over the front month October and what should be a $4 discount this time of year is residing around $15. Seasonally, hog prices forge a seasonal low this week and we look for that to happen again this year.
Pat Garrity has been a commodity broker/livestock analyst going on six years. He, along with his partner, publishes a daily livestock report for clients. Free 30-day trials are available by emailing Pat.