We’ve been waiting for the summer hog market to catch fire, to begin an impressive run higher. Thus far it’s never materialized. Does this mean it won’t?
Recently futures have been pounded lower but the cash hog market and pork cutout values have held steady. Indeed, what we’ve experienced is a massive narrowing of the basis. Instead of summer futures trading at a substantial premium to the cash hog market, the two have narrowed dramatically. Lean hog futures prices have dropped hard while the CME lean hog index continues to edge upward. The latest CME lean hog index stands at $78.81 with June hog futures, on May 20, settling at $79.84. The negative basis of $1.03 basically means that cash and futures should move in tandem. At this time of year, one should expect rising cash hog prices.
My guess is that the sharp decline in futures, at this time of year and in the face of a fully steady tone in the cash market, will at some point soon quickly reverse course and move higher, perhaps sharply higher. In other words, the hog market could well be a sleeping giant about to awaken from its slumber. This likely presents a trading opportunity for the speculative investor and a harvest opportunity to the short hedger. We are covering hedges and moving into bullish option positions with our speculative traders. If short hedges are covered, we’d recommend purchasing out-of-the money puts in the summer months to provide some underlying protection. A portion of the hedge profits can be used to finance these puts. The danger in the weeks ahead lies mostly in the export market. If exports remain solid, hog futures will likely recover and possibly retest the highs from May.
The seasonal tendencies suggest looking for a low in futures approaching the Memorial Day holiday. A seasonal high or peak in lean hog futures can then be expected to develop from the middle of July into the first week of August. Of course, this coincides with a reduction in butcher hog supplies during the summer months.
Clear as mud
Wading through the pork fundamentals can be a difficult exercise on a daily basis. What tends to happen is that the fundamentals become “clear as mud.” In other words, unexpected moves in the futures market tend to keep everyone confused and dazed. Traders have recently experienced this in live cattle and soybeans, as well as hogs.
What we know is that pork remains a cheap source of protein from a historical perspective. Recently the loin sector has attracted strong demand from both the domestic purveyor and our export customers. Pork butts have been red hot this winter and for several months they’ve been priced higher than loins which is extremely rare. Pork trimmings have been in tight supply. Ham prices have recently (post-Easter) peaked but they should begin to attract renewed demand on further weakness. Finally, pork bellies appear to have been very weak this spring. However, it’s important to realize that bellies have been high-priced since the porcine epidemic diarrhea virus-reduced pork production in 2014. Belly prices have been declining from extremely lofty levels, and currently they’re priced near their 10-year average. Going into the strong bacon consumption season (summer), we’re expecting bellies to find traction and begin working higher.
We’ve recommended covering short futures hedges in the summer contracts and replacing these with out-of-the money puts. We continue to recommend holding hedges in the fall and winter timeframe. Our expectation is for the summer hogs to likely bottom out sooner rather than later and lead the board higher developing into a major seasonal low or bottom.
How likely is this to occur? In our opinion, very likely.
With pork prices in China record high, we consider hogs a sleeping giant, wondering when this market awakens.