As I tap away, the August lean hog contract is about $12 under the CME lean hog index, October pigs are priced about $27 under the cash and December futures are sitting approximately $32 under the cash. So, it’s fair to say futures have dialed in a huge break in the cash hog market going into the fall.
The sharp selloff and discounted board has been generated by bearish fundamental developments including major disruptions to the pork export market and confirmation that U.S. producers have kicked expansion into high gear. The June Hogs and Pigs report seemed to indicate that U.S. producers, feeling overly confident due to increased slaughter capacity and a robust export market, actually accelerated expansion plans just prior to the major disruption of the U.S. export market. This incredibly bad timing will most likely contribute to widespread losses in the industry in the months ahead and end the expansionary phase of this hog cycle. It would appear that China is several months ahead of the United States. Recent data confirmed that contraction has started in the Chinese hog breeding inventory.
However, talking contraction is premature because the cards have been dealt which assures another round of record large pork production coming down the pipe next year. The efficiencies in the industry virtually assure there will be more pigs on the ground a year from now.
The issue of solving our export bump is more critical than ever. However, the market place is currently in the process of solving the export problem, not waiting on the politicians. Mexico is our largest buyer of hams. Mexico slapped a 20% tariff on U.S. hams effective July 6. However, current ham prices are down 30% from this time last year. In addition, compared with one year ago, the dollar is weaker and the peso is stronger. In other words, ham prices when converting pesos to dollars are more than 30% cheaper than they were one year ago. Hams are only part of the carcass. Every pork cut is currently trading at levels lower than last year. All cuts, with the exception of fresh bellies, are trading not only lower than last year but also lower than the last three years. In other words, pork is being offered at a tremendous discount to our export customers. This is what I mean when stating the market is taking care of the problem and not waiting on the politicians.
The USDA supply-demand report, issued on July 12, showed projected pork exports for this year and next year unchanged from the previous forecast 30 days earlier. When the USDA was challenged on their forecast, their response was eye-opening and it’s what prompted me to begin this investigation. The USDA indicated they left export projections unchanged because they believe that lower pork prices will stimulate higher exports to the “other countries” effectively making up for lost business to China and Mexico. That’s when I realized that ham prices are already low enough to effectively make the tariff a moot point.
The issue of record large production in the face of peaking and possibly declining exports cannot be ignored. However, it’s currently my opinion that, in the case of lean hog futures, traders have overreacted to the bearish news developments. That’s what futures markets do during the price discovery process. The pendulum swings back and forth until eventually the correct price level is identified.
Technically, hog futures experienced a massive three-day selloff July 9-11. This break down in prices occurred on very heavy volume of trade, exceeding 100,000 contracts on both the July 10 and July 11. After a sharp two-day recovery back upward, prices have since pulled back and penetrated the previous lows. This has occurred in the August, October the December contracts whereas the February through June contracts have not penetrated the recent lows. In addition, the penetration of the lows in the August through December contracts has occurred on much lower volume of trade.
On the weekly chart, the $65 level represents solid support. This level was tested as the May contract went off the board. The seasonal tendencies suggest a near-term low could develop this week with a major seasonal low in the market not due until the very end of August or early September.
My columns the previous two months discussed the need to hedge. Last week we lifted most of these hedges. The need to be hedged certainly still exists, but at the tremendous discounts identified in the first paragraph, we decided to take the profits and stand back a minute. I suspect it won’t be long before this strategy will be proven to be on target or foolish. Indeed, we’ll let the market do the talking.
As mentioned in the first paragraph, the August hog contract is currently trading around $12 under the CME lean hog index. The normal basis for August futures on Aug. 1 is for the contract to be $1 over the cash, thus the argument that we’re currently $13 undervalued. The October contract resides about $27 under the cash with the normal basis for this contract near Aug. 1 from $7 to $14 under. December futures are trading $32 under the cash with their normal basis in late-July/early August around $10 to $17 under. Repeating, I consider all of these contracts to be currently undervalued.
Finally, news of the trade war, tariffs and resulting impact on the livestock markets, specifically the hog market was reported on the front page of the July 23 Wall Street Journal. There’s an old saying in the industry that by the time market-moving news hits the front pages of the newspapers, by the time everyone has heard the story and reacted to it, that’s typically when the market will reverse course.