February appears to have been a really lousy month for pork demand. With production record large and actually coming in above expectations, any hiccups in demand spell trouble for U.S. pork producers. Losses have been sustained consistently since last fall. Perhaps the expansion is rapidly ending and decreased gilt retention is responsible for increased butcher hog numbers this winter.
Measuring gilt retention is extremely difficult. It appears the industry is challenging demand and demand, frankly is just not measuring up. Of course, retaliatory tariffs on U.S. pork by Mexico and China have hurt demand. In my opinion a stronger lobby effort on behalf of the U.S. pork producers is necessary. All of the talk, all of the concern is focused on the soybean producers.
Lean hog futures have collapsed in price and filled long-term gaps on the charts going clear back to last August. Admittedly, I never thought this steep of the pullback would occur in light of the disease situation that continues to unfold in China. Gaps on the charts have been filled in the April, June and July contracts. Gaps from last August in the August, October and December contracts remain unfilled. Recall these gaps were established last August when African swine fever was first detected in China. April hogs proceeded to plunge through their summer lows in dramatic fashion. Last week it appeared part of the intense selling pressure was the result of a very large hog-cattle spread position that was unwound.
In summarizing the current fundamental situation, we have pork production for this year projected to come in at 27.340 billion pounds, up just under 4% from last year. This is record large production. However, year-to-date pork production is up nearly 5% despite three weeks of tough winter conditions causing slaughter disruptions. So, either the Hogs and Pigs report data are wrong or expansion and gilt retention has come to a screeching halt. Frankly, I’m hoping that the Hogs and Pigs report at the end of March will indicate that expansion is ending. We’re somewhat lost on export data due to the government shutdown. Exports are projected to rise 6% this year and also be record large. Beef and poultry production are projected to be record large. Tariffs remain in place from both Mexico and China on U.S. pork.
I still contend that the ASF story will dominate the fundamental news before the end of this year. I’m not interested in downplaying the impact for fear of getting my producers trapped in a rapid acceleration of hog prices at some point this spring/summer. My memory of the huge rally that occurred in the spring of 2014, the porcine epidemic diarrhea year has been seared into my mind. That was a very tough year for any pork producer who was hedged. June futures went from $1.05 in mid-February to $1.32 in a seven-week period. The $32 rally (from the January low) was also accompanied with several margin increases imposed by the CME, putting additional pressure on the short hedger. Lines of credit were stretched to the limit and many producers were forced out. The net pig loss from PED turned out somewhere between 6 million and 8 million pigs. In my opinion, this pales in comparison to the number of pigs currently being culled and/or liquidated in China.
We believe the information flow in regards to the spread of ASF throughout China continues to be restricted dramatically by the Chinese government. This is actually normal behavior for the Chinese. Here’s what we know to date. ASF has been confirmed in 28 out of 34 provinces covering virtually the entire country from the northeast to the southwest. The spread has become regionalized as it’s been confirmed in Mongolia to the north and recently confirmed in Vietnam to the south of China. Mongolia is not a large pork producer.
However, Vietnam contains 30 million pigs and the population of Vietnam (95 million) considers pork their staple. Pork equates to three-fourths of their meat consumption. We know that efforts by the Chinese government to control the spread of ASF have been largely unsuccessful. We know that a panic herd liquidation started in December and likely continues to date. We know that the pig population in China was 430 million head or larger when ASF first hit last August. We know the breeding herd population was about 40 million when ASF first hit. We know that ASF is hitting the small courtyard producer first and hardest. We know that small courtyard producers equate to 30% to perhaps as much as 40% of the pig population. We know that China is the largest pork producer in the world and we know that the Chinese consume more pork than the rest of the world combined.
Finally, we know that pork is the staple in China and history has indicated they won’t simply switch protein sources.
History has demonstrated that it will likely take years before ASF is eradiated from the Chinese hog herd. Doing some math provides startling numbers regarding possible losses due to death from ASF, culling to prevent spread of the disease and panic liquidation for fear of contracting the disease. Over the next few years, if 10% of the herd is lost you’re talking about 40 million pigs, if 40% of the herd is lost, you’re talking about 170 million pigs. I’m not even factoring potential losses in Vietnam.
For comparison, we lost 6million to 8 million in our PED year. The entire U.S. pig population currently resides at 75 million pigs which includes about 7 million sows. My knowledge of the potential losses occurring is why I’m very hesitant to position from the short side even for hedgers until more is known and I believe a truer market reaction has occurred. Granted, since the November highs were reached this caution appears unwarranted.
The most important fundamental development immediately in front of us is a resolution to the trade dispute with China. U.S. pork producers need to see the Chinese tariff on U.S. pork removed as soon as possible. There’s talk that part of the agreement will include Chinese purchases of an additional $30 billion in U.S. commodities annually to drastically reduce their trade deficit with the United States. Using 2017 as a base, this would mean about $50 billion per year in agricultural purchases made by the Chinese.
Be aware that the Chinese will only buy, in large quantity, only those commodities which they need. For example, if they don’t need wheat or if U.S. wheat is not competitive, they won’t buy wheat in large quantity. In my opinion, they need pork, or will soon need pork and they’ll come in and purchase huge quantities of U.S. pork.
In summary, I can’t explain the lull in pork demand that has occurred since the start of the year. Domestically, pork demand should improve as the weather improves. Low cash hog prices and sustained losses experienced by U.S. pork producers for the several months, in tandem with the threat/fear of ASF spreading to North America, could be fostering an abrupt end to the current long-term herd expansion.
Ironically, a possible herd contraction in the United States may be underway about six months prior to a buzz saw explosion in pork demand engineered by the Chinese. Finally, for what’s it is worth, on the verge of reaching a trade agreement with China, I consider hogs and corn undervalued and soybeans overvalued.