Price Outlook

Kevin Grier, Senior Market Analyst

As can be seen from Figure 1, U.S. hog prices started 2006 below the average of the previous five years but by mid-year, pricing bounced sharply higher. Average prices in 2006 on a carcass basis were about US$64/cwt. That is about $4/cwt better than the average of the previous five years.

Of course whether those margins can continue into 2007 will be a function of both the hog price and the cost of grain. In that regard, based on some forecasts of hog pricing in the first half of 2007, the break-even corn price is estimated to be around $4.25. Based on current corn futures, corn pricing will prove to be a major challenge to hog producers. As of now, however, corn futures do not suggest a major breakthrough above $4.25. With that noted, however, given the livestock and ethanol demands placed on the corn crop, 2007 is going to be a very volatile year for hog producers with regard to feed pricing.

With regard to hog pricing, the place to start is on the supply side. Since my last quarterly report to Alberta producers, the United States Department of Agriculture (USDA) released its December Quarterly Hogs and Pigs Report. The report provided a picture that was very similar to previous reports over recent years. That is, U.S. producers are planning a steady, cautious increase in sow numbers and marketings over the next year. Figure 2 shows U.S. sow farrowings by quarter from 1983 through the expected sow numbers in the first two quarters of 2007.

As can be seen on the graph, since 2001 there has been a slow year-over-year increase in the numbers of sows farrowing in the United States. What is particularly interesting is that despite the last 35 months of profits, the U.S. producer has continued that same slow expansion pace.

An important point to take away from that last fact relates to the ramifications for 2007. If 35 straight months of profits did not make the U.S. producer rush to expand, then I do not see how potential losses in 2007 will make that same producer want to retrench. That is, even if grain prices soar to the point where U.S. producers are in a loss position, I would not forecast that the U.S. industry will begin to cull sows significantly, at least not in 2007.

Separate from the glimpse of the future that Figure 2 provides, I think that the graph also provides a very interesting look at the past. Notice how volatile hog numbers were in the U.S. right up until 1998. Prior to 1998, U.S. producers responded to positive or negative margins by either ramping up or shutting down sow numbers. In other words, prior to 1998, the U.S. industry was more easily characterized by producers who either got in and out of the industry, depending on profits, or simply responded only to margins. The pricing crash of 1998/99 changed all of that. After that crash, it appears that the industry was more in the hands of commercial hog producers who were in the market for the long haul. That again is all the more reason for me to suggest that if grain prices make margins sink in 2007, that the supply response will be muted, at least in 2007.

Within that context, it should not be surprising that the gradual increase in sow numbers is going to translate into a gradual, 1 percent increase in slaughter during 2007. That modest increase in slaughter should in turn mean up to a 1.5 percent increase in U.S. production. Given grain costs, carcass weights may even decline in 2007. In any event, total U.S. production will once again hit record high levels in 2007.

With the supply side of the picture reasonably clear, the demand side needs to take focus. With regard to North American demand for pork, generally speaking the industry has been characterized by stability. U.S. and Canadian demand for pork does not change much. In fact in Canada, pork demand during 2005 and 2006 has exhibited a weakness that is beginning to be a cause for concern. The key point is that the industry cannot look to domestic demand to absorb the increased production.

That of course brings us to export demand. On that front, the news tends to be very positive. Figure 3 shows U.S. monthly exports of pork for this year and last year.

The good news is that U.S. pork exports are soaring. The bad news is that one of the places that it is soaring to is Canada. Fortunately, other destinations such as Korea, Japan, Russia and Mexico are also pulling plenty of product off shore as well.

The net result is that U.S. production combined with imports and exports is still going to leave that country with record supplies in the market during 2007. Despite that fact, I am still forecasting relatively strong pricing during 2007. In fact, even though overall supplies are going to be about 1 percent higher in 2007 than in 2006, I expect prices in 2007 to be slightly stronger than in 2006. This would continue the experience of the last few years in which higher supplies do not necessarily translate into lower prices. Figure 4 illustrates that point.

On the vertical axis the graph shows U.S. hog prices on a carcass basis and the horizontal axis shows domestic U.S. supplies (production plus imports less exports). The points on the graph show the years in which the combination of price and supply occurred. As can be seen during the 2000s the pork industry has been able to support hog prices at exceptionally high levels relative to supplies. As such, I am forecasting that 2007 pricing will amount to about US$64-66/cwt for that year compared to about US$64 in 2006. My forecasts for the second, third and fourth quarters of 2007 are US$72, 69, 59 respectively. Note that as of late January, those forecasts are materially lower than current futures. If prices go as high as futures suggest, it would be an unprecedented surge in the face of huge supplies. So if you believe my forecasts that may be a sign that it is prudent to take some protection.

Moving into Alberta, as I noted in the last quarterly report, the forecasts are very much contingent on the Canadian dollar (C$) wild card. During the last report, my forecasts for 2007 assumed an 0.88 C$. That may be a little on the high side.

The following is a commentary on the Canadian dollar by CIBC World Markets, Monthly FX Outlook, January 17, 2007
(http://research.cibcwm.com/res/Eco/EcoResearch.html).

“We were not surprised by most of the past quarter’s retreat in the C$, having already forecast a retreat to the 1.15 C$/US$ level for 2007. Simply put, the decimation of Canada’s manufacturing sector demonstrated that a much firmer currency was not tolerable over the longer run. With earlier large M&A inflows abating, and energy prices well off their peak, the loonie had nowhere to go but weaker, a fact picked up by speculators as they moved to record short-C$ positions.

Looking ahead, a less rosy near-term environment for both oil and natural gas could see the C$ sell-off extend a bit further, and we weakened our March-end level for the loonie as a result. That will also be encouraged by U.S. dollar resilience. We’re in the process of raising our U.S. GDP outlook for Q1, firmer than expected consumer spending in the prior quarter drained inventories, leaving room for a production pick-up. That’s not entirely bullish for the dollar, since American imports are likely to accelerate to the detriment of the non-petroleum trade deficit. But it has pushed off the calendar for any Fed easing towards midyear. We still see the next U.S. rate move as a cut, but only when the deterioration in housing has slowed consumer spending and employment growth sufficiently to open up slack in the economy.

Further to that point, when doing forecasts, I tend to simply rely on the C$ futures markets. That is because I have never found any organization that could do an accurate job of forecasting the C$. In that regard, as I write this, the C$ futures are trending from a nearby of just under 0.85 to the deferred contracts at around 0.86. Based on my U.S. hog forecasts, and using an 0.85 cent C$, the following are the Alberta index 100 forecasts for the last three quarters of 2007.

A U.S. consumer slowdown will be felt north of the border, prompting the Bank of Canada to match any American interest rate cuts later this year. As a result, we don’t see the loonie gaining against the dollar alongside overseas currency appreciation. A slightly stronger C$ will be the product of improved oil prices in 2008, but don’t expect a return to 1.10 C$/US$ or, even less likely, parity. Markets have already seen enough evidence that the Canadian economy can’t live with a much stronger C$ than we’ve already experienced in this cycle, and will look to other currencies as US$ alternatives.”

Prairie Situation

In the west, domestic packers continue to show no interest in pulling hogs through their plants. Packers’ hearts are not in their work. During January, total Prairie kill is down by about 7 percent from the same time last year. Even accounting for the fact that Olymel was running a double shift last year at this time, total kill would still be down by at least 3 percent on a year over year basis. At the same time, however, the supply of slaughter hogs has not been causing any pressure. Despite the lack of kill on the Prairies, market hogs are not lacking for hook space. Not only are sow numbers stagnating, but the weaner exports are taking increasing share. On a year over year basis, weekly feeder pig exports through North Dakota have grown by 19 percent each week from August through the end of 2006. Prairie barrow and gilt exports through North Dakota have declined by 7 percent. Over the same time frame, prairie slaughter has declined by 1 per cent. Prairie producers are responding to pricing signals given by Prairie packers.

February 2007