After a Tough Week - Now What?

Last week's tough week for Lean Hogs futures at the Chicago Mercantile Exchange (CME) translated quickly to a tough week for cash hog prices, too. A healthy rebound on Tuesday and smaller increases Wednesday and Thursday have eased some of the pain, but it has left many wondering just what has hit this hog market the past couple of weeks.

The answer, as is often the case, is that there has been a combination of factors and they all went one direction for a short time period.

First, hog supplies have been slightly larger than expected since Dec. 1. USDA's 180-lb. and over inventories on that date indicated that slaughter should have been up 0.1% or so over the past few weeks. It has actually been up 1.7%. That is certainly a significant deviation. The question is whether or not it will persist.

Some think this may be an indication of an undercount by USDA. Others think that exceptionally mild weather may have helped improve performance, thus pulling a few hogs forward. It is way too early to judge whether the undercount argument and higher weights (at least until last week) would support the enhanced performance argument. But I'm not sure mild winter weather translates into higher daily gains. Since intakes are already high, don't they really translate into better feed efficiency (less feed burned for warmth) and lower heating bills?

Second, pork cutout values have been under pressure since mid-December and, as of this week, have reached their lowest level since early 2004 (see Figure 1). Wholesale demand still appears soft and extremely low chicken prices are one reason. Figures 2 and 3 demonstrate just how low chicken part prices are -- record low for boneless/skinless breasts and 50% lower than on Oct. 1 for leg quarters. That means the U.S. broiler industry is ultra competitive in both domestic and export markets and can put some pressure on pork demand on both fronts.

Finally, there is the post-holiday lull in consumer activity. Whether everyone is still stuffed from holiday feasts or their credit cards are stuffed to the limit, pork demand always seems sluggish at this time of year.

Hope on the Horizon
There is hope. Slaughter runs of over two million head are not unusual in early January. The pig spigot is not turned off at Christmas time. But those runs usually moderate some as we go into February. In addition, decent packer margins have helped cash hog bids this week and, while supplies are good enough that we won't see convergence of hog prices with cutout values, it feels like we may have found a floor -- provided cutouts don't fall out of bed.

And, it appears that CME Lean Hogs futures have found their fighting legs, too. Most of the damage was done in the February contract and it still looks somewhat risky. A $5 premium to the Lean Hogs Index will be reconciled sometime between now and Feb. 14. Outside of February, April and the fall contracts were the hardest hit by the recent decline. The summer contracts are lower, but not dramatically so.

This is not the time to panic, but I'm still thinking producers should be engaged in ongoing consideration of pricing 2006 production. Barring some unforeseen circumstances, there will be some seasonal strength in cash hog prices and futures prices usually honor that strength (the old adage is "Cash is king!"). Current futures prices are still generally above the four forecasts shown in Figure 4 (LMIC is the Livestock Marketing Information Center in Lakewood, CO). Basis levels will be from $2-$3/cwt. for all except the Net Price series shown in the first column of data in Figure 4.

Risk management and forward pricing require careful thought, rational decision-making and action. Use your head, do your profit margin and rate of return calculations and make a decision about pricing hogs. The decision may be to wait. I know I'm a broken record on this, but make sure that any delay in action is a conscious decision, not an act of omission or procrastination.

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Steve R. Meyer, Ph.D.
Paragon Economics, Inc.