As hog numbers and pork production have been approaching their highs a remarkable thing has occurred, futures have established a solid uptrend. There are several forces at work to help explain the recent action. The bearish fundamentals include the continued outlook for record large production next year, most likely continued expansion in hog breeding numbers, headwinds created by continued tariffs against pork going to China and Mexico and widespread concerns regarding a global economic slowdown over the next year.
The positive fundamental forces at work appear to be outweighing the negative forces. The first is that it appears producers have managed to remain current in their marketing into the peak production season. The most recent data indicated that average live hog weights were running just over one pound lower than this time last year. When dealing with record large numbers, remaining current is critically important.
Second is the fact that pork is cheap, historically cheap. The old saying that cheap prices cure cheap prices certainly applies in this instance. Hams are trading at 10-year lows. Some pork tenderloin cuts are trading below 30-year lows. Boneless pork loins are priced $20 below pork butt prices. The bottom line here is that protein priced at such attractive levels will indeed spur large consumption.
Third, and this is most important if indeed its accurate, there’s compelling evidence bubbling to the surface that today’s economic environment is contributing to a long term shift in consumer preferences toward red meat and away from cheaper priced poultry. Again, if this consumer trend is confirmed, this will be very supportive of hog prices in the weeks and months ahead.
Fourth, despite the major headwinds created by current tariffs on pork implemented by Mexico and China, September pork exports were up 2.6% from September of last year. Third quarter pork exports were up 5.3% compared to the third quarter of 2017. The top ten United States pork export customers include Mexico, Japan, China/Hong Kong, Canada and South Korea. The next five countries (in terms of export volume) include Colombia, Australia, the Philippines, the Dominican Republic and Honduras. Exports to the bottom five and South Korea were sharply higher during the third quarter.
Finally, the fifth bullish fundamental driving force is the continued spread of African swine fever in China. Indeed, as we’ve discussed and underscored in past articles, the situation in China represents an extremely bullish development for U.S. hog prices in the months ahead.
The powder keg situation that ASF represents cannot be over stated. This disease has spread to 20 provinces and is believed to be impacting over 80% of the pig population in China. We have limited information regarding how many animals are being culled. However, it is highly likely that the crippling effect on pork production in China in the months ahead will force them to import increasingly larger quantities of foreign pork.
There will be two main sources for this surge in demand, the U.S. and the European Union. The lean hog futures market has been in a wait and see attitude regarding ASF until recently. Recent weekly pork export data (the last two weeks) showed pork shipments at a marketing year high with Hong Kong representing the second largest buyer of U.S. pork. When this data hit the wire lean hog futures soared to a limit up performance. Experiencing a limit up performance and seeing a market move from downtrend into an uptrend in the face of record large production is extremely rare. Nevertheless, this was and is the situation.
Estimates regarding how many pigs may be culled in China due to ASF varies dramatically. I’ve seen estimates as low as 1 million and as high as 30 million. The latest figure from the Chinese government is that 600,000 pigs have been culled since August. Most in the trade, including myself, believe the actual number is far larger. For perspective, in 2013/14, porcine epidemic diarrhea virus caused an estimated 6 to 8 million pigs to be lost in the U.S. Hog prices went ballistic.
Preparing for a sharply higher market while maintaining some degree of risk off approach is most challenging. Our strategy, quickly implemented early last fall when the ASF story first broke, was to cover all futures hedges and replace these with December puts. Thus far the strategy has worked nicely.
A seasonal high in lean hog futures can be expected at the end of November or perhaps by the end of the first full week of December. Some short of hedging strategy should be implemented during this seasonal high timing. Hope for the best and plan for the worst. The worst case scenario would be if ASF shows up in North America. Our strategy will include using February puts to protect production in first and second quarter with deep out of the money puts used as an ASF worst-case protective measure.
Looking ahead, key dates to keep in mind include Dec. 7 and Dec. 21. On Dec. 7 the commerce department will release monthly meat export trade data for October. On Dec. 21 the USDA will release, during trading hours, the monthly cold storage report, cattle-on-feed report and quarterly hog and pig inventory report. The release time for all three reports is 11:00 Chicago time so the futures market will have two hours to trade following the release of the information.
Finally, as the Trump Administration moves to ratify the new North American Free Trade Agreement, now called the United States-Mexico-Canada Agreement, look for the strong possibility that tariffs on steel and aluminum to be dropped in correlation with Mexico dropping tariffs on U.S. pork. This, of course, would be beneficial to ham prices. The trade dispute between the U.S. and China looks to drag on into early next year. It is highly possible, however, that the continued spread of ASF in China could actually bring them to the negotiation table sooner rather than later. The Chinese government will implement every measure at their disposal to prevent a surge in pork prices.