The week ending Sept. 23 was a rough week for lean hog futures trade. The front month October contract gapped lower twice during the week and plunged into fresh contract lows on Thursday and Friday. The October contract has lost nearly $10 during September. Typically September is a bullish seasonal timeframe that sees the October hogs rally. Not this year.
The disappointing aspect appears to derive from what’s so far been the strong suit of the pork market — demand. As slaughter has risen, resulting in record large production, buyers appear to have stepped back. Bellies have dropped hard and fast since trading to all-time record highs in late-July. Hams have recently dropped hard as our main buyer, Mexico, seems to have backed away from the market during the North American Free Trade Agreement negotiations. Retail pork cuts are under pressure as well.
The pork cutout dropped hard this week and is now actually close to levels which found value last year. The pork cutout traded sideways last fall near $72 for what appeared to be forever. We did not realize it at the time, but huge demand for U.S. pork was absorbing production at this value level. One year ago everyone feared a crash in hog prices dictated by overproduction and with the fear that slaughter capacity was being challenged. The big crash never occurred. One main reason was because packers were operating at profitable margins and thus willing to schedule many hours of overtime. The slotting of market hogs was never necessary as it was in the fall of 1998.
In reflection, the June Hog and Pig Report showed the kept-for-breeding herd up by 1.5%. The impressive efficiencies in hog production continued, resulting in record high total hog and kept-for-market hog categories. Until last week, the market appeared to be up to the challenge in regards to handling record large production. The USDA will issue their September quarterly Hog and Pig report later this week, on Sept. 28. We’re assuming that slight expansion of the U.S. breeding herd will be confirmed in this report.
The expansion of slaughter capacity is now in place with daily capacity moving from 450,000 pigs per day to nearly 500,000 per day by 2019. Recent daily kills have been record large at 455,000. The bearish hog trader seems to believe that cash will continue to drop like a stone under the weight of such production. Consider this prospect unlikely. Demand for U.S. pork is expected to continue expanding both in the export arena and in the domestic market. U.S. pork is high in quality and inexpensive. As consumer incomes grow and population increases, demand for U.S. pork will expand.
The U.S. hog market is a global market. We’re currently exporting close to 25% of total production. The U.S. beef market, in sharp contrast, only exports about 11% of production. Growth in pork exports is occurring in many countries with the exception of China. U.S. pork exports to China are down significantly. Last year the United States lost the battle for Chinese business to Europe as they were more price competitive. That’s not really the case now. However, the onset of corporate hog production in China has been successful with production rising and domestic pork prices declining. For now, their import needs are just not as large as expected. What’s impressive is that pork exports are growing steadily in the absence of the Chinese market.
The seasonality of lean hog futures trading is currently all out of sync. When this occurs, it makes trading and predicting major moves in lean futures extremely difficult. This is one of those times. Normally major lows are made in hog futures in early September and again in mid- to late-November. As discussed above, futures have plunged into fresh contract lows in late-September. So the seasonal tendencies are all out of whack. Seasonal high tendencies are important for producers to watch and monitor, especially in times of record high production. For example, in the June hogs, seasonal peaks can be anticipated in early December, again in early February and sometime around mid-March.
Hammering out a viable revision to NAFTA is vital to U.S. pork producers. Hog producers should always have a basket of puts on the books, in my opinion. Focus on purchasing such puts at the peak timing periods outlined above.
The USDA issued a monthly cold storage report that was generally friendly to the hog market. Basically, despite the fact that year-to-date slaughter is up 2.7%, the report shows lower frozen pork stocks at the end of August than last year at this time. Simply put, that confirms outstanding demand for U.S. pork. Specifically, total pork was down 5.5% from last year. Picnic stocks are down 4%, hams are down 10% and bellies down 41%. Rib stocks are down 2% with stocks at a 52-week low with pork variety meat down 27% and also sitting at a 52-week low. Some retail cuts are higher than last year with loin stocks up 4.4% and butts up 6%. Pork trimmings are up 5%. This report, at the very least, confirms that pork is not piling up in the nation’s warehouses.
While demand is definitely being challenged, it’s our opinion that demand will likely meet the challenge. Millions of dollars have recently been invested in expanding U.S. hog slaughter capacity. These packers have their fingers on the pulse of pork demand. Their diagnosis about two years ago was that demand will continue to surge. Recent evidence tends to confirm this diagnosis.