Prior to the increase in specialized farming, diversified farms often viewed hogs as an alternative strategy for marketing corn. If corn prices were low the farmers would “walk the corn off the farm” by feeding hogs. If corn was more expensive or livestock too cheap farmers would sell corn and reduce livestock numbers. The old rule of thumb was that if the hog:corn ratio was above 18 or 20 the associated profitability would lead to expansion of hog inventories and lower hog prices in the future. The opposite was said to be true for values below 18 or 20.

Today’s production practices are more complicated and fewer farmers are willing to switch into and out of a commodity enterprise. Increased specialization in grain and hogs, and the higher capital requirements of each, make such diversification more of a challenge.

So do the old price relationships still hold? To address this question and identify potential indicators of future market direction, we evaluated the quarterly average hog:corn ratios during the period between July 1989 and July 2006. While there is a lot of variation in the values, there are some generalities to consider.

Figure 1 shows the relationship between the hog:corn ratio and live hog prices two quarters later. Notice there is a slightly positive relationship; however, plenty of variation surrounds this trend line. For example, when considering a hog:corn ratio of 20, hog prices two quarters in the future ranged from $30 to $55. This difference in hog prices may be due to reduced gilt slaughter at the start of the expansion phase of the hog cycle.

Figure 2 shows a the relationship between the hog:corn ratio and live hog prices four quarters out. Note that the line is nearly flat suggesting very little relationship between the ratio and prices a year later. There is still plenty of variation around the trend line.

Figure 3 is the hog:corn ratio and live hog prices six quarters later. Now the trend line slopes downward suggesting that higher ratios lead to lower hog prices six quarters in the future. This relationship is consistent with the idea that profits reflected in a high ratio (higher hog prices and/or lower corn prices) result in an expansion of hog production and pressure on prices at a future date. Again, there is significant variation around the trend line and it is difficult if not impossible to predict hog prices into the future from this method, but the odds of getting the direction correct have improved.

Figures 1, 2, and 3 show the general relationship between the hog:corn ratio and hog prices at a later date. Figure 4 shows the change in the hog:corn ratio over the next four quarters, sorted by beginning ratio. We can now begin to see more indicative predictability in this relationship. While there is still a lot of noise in the middle of the spectrum, there is a stronger message on the outer ends of the range. During this time period, the hog:corn ratio increased a year after a quarter when the ratio was below 15 in nine out of the nine occurrences. In eight of the ten times the ratio was above 25, the ratio was lower a year later. When the beginning ratio was between 15 and 25 the ratio increased 21 times and decreased 25 times.

For the past year the ratio was 31.4, 29.1, 24.0, and 26.9 in Q305, Q405, Q106, and Q206, respectively. While past performance is not a guarantee of the future, this analysis points to a smaller hog:corn ratio and narrower margins in the year ahead. Current forecasts of higher corn prices and lower hog prices concur.

November 2006