Hog Futures Slide As Competing Meats Grow

First, a correction is in order to last week's North American Preview. While actual federally inspected (FI) hog slaughter during March of this year was 3.5% larger than last year, I made a critical omission in my year-over-year comparisons: adjusting for a holiday last year. Easter 2005 fell during March. That didn't cause an entire lost day as would Thanksgiving or Christmas, but it did cause short days on March 25 and 28. Adjusting for those short days leaves March 2006 slaughter 1.6% larger than a comparable March 2005 slaughter (23 full weekdays and four Saturdays), and that number is very close to the March Hogs and Pigs Report over-180 lb. estimate of +1.7%.

After a positive Monday on Chicago Mercantile Exchange (CME) Lean Hogs futures, this week has seen a continued decline in CME Lean Hogs futures, with April making four consecutive contract life lows, and both June and July breaking support at $65. The August, October and December contracts are now nearing support lines at $62.50, $53.50 and $51.20, respectively. Should those be broken, the next support for August would be at $60, and the next objective for October and December would be contract life lows near $50, made either on or just after the contracts came on the board.

The meat complex got a bit of help from lower cattle weights last week, and those declines are expected to continue as the market sees the effects of the recent large snowstorm in the Northern Plains. Federally inspected cattle slaughter through Thursday was still nearly 5% larger than last year, so beef production rolls along.

And chicken production for the week that ended March 25 was 10% larger than last year. Goldkist CEO John Bekkers told a March 14 conference held by Stephens, Inc. that the current financial situation for chicken producers is worse than in 2002 and 2003 due to low white meat prices. He said that Goldkist had made some cutbacks amounting to about 3.25% of production. These followed, though, a statement during his prepared remarks that "We have a very disciplined strategic plan that we continue to execute without regard to what's happening in the market." In other words -- Damn the Torpedoes. Total broiler egg sets for the week ending April 1 were 0.5% higher than one year ago. That increase is smaller than in previous weeks, but the year-to-date total is still 0.75% larger than last year.

Growth in the Pork Sector
Amid all of this, there will also be more growth in the U.S. pork industry. Veteran pork sector banker Lee Fuchs, now with Farm Credit Services of Missouri, told the National Pork Board's Pork Management Conference this week that he knows of 140,000 more sows that will be in production by mid-2007. I have seen similar lists that did not have quite that many sows, but I think Lee has a better view of a broader market area than do the authors of the other lists I have seen. That increase would represent 2.6% more growth and bring the two-year total to 4%.

The question of productivity gains remains unanswered at this time. Recall the graph in Figure 1 that shows the historic positive relationship between sow herd change and productivity. I have added an observation for Q1-2007 based on Lee's growth prediction.

Hog Expansion Like No Other
It is difficult to predict how these relationships might play out for this hog cycle. First, note that this "expansion" is like no other. Since the high point of liquidation of the last cycle (Q1-2003 at -3.3%), we have seen only five positive quarters out of 12. It normally takes about five quarters to get back to positive, and then we stay there for a while. This thing is slow.

Second, the magnitude of productivity gains is definitely slowing. The rapid growth of the '90s was driven by new technology, structural change and better management systems. The rate of change for all three of those variables has now declined as the law of diminishing marginal returns comes to bear. There just aren't as many places to make easy improvements. Add in a few porcine reproductive and respiratory syndrome (PRRS) (and now postweaning multisystemic wasting syndrome or porcine circovirus-Type 2) outbreaks, and we just aren't jacking up the efficiency like we were.

That is not to say that efficiency will not grow. Litter size set a new December-February record. That's the 10th-consecutive quarterly record. The new serum treatment for PRRS is having some success. The new circovirus vaccine is being used in Canada on an experimental basis. New hog buildings are still clean and productive, and there will be less trial-and-error in managing these new buildings since they are mainly being built or managed by entities already familiar with how to run a hog farm.

Gauging the Impact of Future Production
Let's consider how much larger production could be by the end of 2007: Pencil in that 2.6% breeding herd growth. Add in 2-3% productivity growth and another 1% for higher weights (only very high corn prices will prevent that) and you get 5.5 to 6.5% higher pork production. Even another 20% increase in exports will account for only 2.5% of that, leaving 2-3% more for U.S. consumers to consume.

By the way, Lee's topic at the conference was "Preparing for the Downturn."

Click to view graphs.

Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com