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Livestock Price Outlook - October 2004

by 5m Editor
14 October 2004, at 12:00am

By Chris Hurt, Extension Economist, Purdue University - In his latest Outlook report, Chris Hurt indicates that the hog industry has emerged from the financial darkness last spring, and that profits have been excellent this summer and are expected to be very good for the next 12 months.

Chris Hurt
Extension Economist
Purdue University

More Good Days Coming for Pork Producers

Higher hog prices are being driven by strong pork demand which is expected to continue into 2005. The large corn and soybean crops have resulted in plunging feed price and dropped costs of production by about $10 per live hundredweight since spring.

In the coming 12 months 51% to 52% lean carcasses on a live weight basis are expected to average near $49. With costs in the higher $30’s, profits (returns above all costs) may approach $10 per live hundredweight or about $25,000 for each 1,000 hogs produced.

The favorable profits are expected to result in the largest U.S. expansion since 1997 and 1998. Farrowings could increase by four to eight percent over the next 18 months. If so, hog prices will begin to drop cyclically in the late summer of 2005 and reach their lowest levels in late 2006 and early 2007. At this point, 2004 and 2005 appear to be excellent price years with 2006 and 2007 being the lean years, particularly 2006.

The Numbers

In the just released September Hogs and Pigs report, USDA said that producers are already expanding. The breeding herd has already risen by one percent and farrowing intentions for this fall and winter are up one percent as well. In past years, herd expansion was often led by the major corn producing states.

However, with changes in location of production and with an industrialized production sector, that is less true this time. While Iowa producers reported a three percent expansion of their breeding herds, North Carolina is up five percent, Colorado is up eight percent, and Texas is up 16 percent.

Illinois, with very good corn and soybean crops has a two percent reduction in their breeding herd. Minnesota, with below average crops, also reports a two percent reduction. Other Midwestern states with reductions are Nebraska (down 4%) and Wisconsin (down 17%). Indiana’s breeding herd was reported as unchanged.

The number of market hogs that were over 180 pounds on September 1 was up five percent and the actual head count in September was very close to that. This provides an early indication that the USDA report was reasonably on track with their hog count. Pigs that will come to market in roughly October and November (60 to 179 pounds on September 1) were about one percent less than the year-ago levels. Pigs less than 60 pounds on September 1 were up one percent. These pigs will come to market in roughly December through February of 2005, (see Table 1).

Producers reached a new milestone this summer as the national pigs per litter achieved 9.0 for the first time. Ten years ago, in 1994, this number stood at 8.22 pigs, and 20 year ago, in 1984, producers achieved just 7.6 pigs per litter. Most of this improvement however, was gained by the late 1990’s and in the past five years, only modest improvements have been posted.

Pork Supplies Rise with Higher Weights

Over the coming 12 months, pork supplies are expected to be about 1.5 percent higher than in the previous 12 months. This fall, supplies will be nearly unchanged from the same quarter one year ago. A rise near one percent is expected in the winter, before moving upward by nearly three percent in the second and third quarters of 2005. The three percent increase by next spring and summer is due to the one percent increase in farrowings, to larger anticipated live hog imports from Canada, and to heavier marketing weights.

Marketing weights bear a special mention. Carcass weights have been trending higher by about 7/10ths of one percent since 1990. In the next 12 months, carcass weights are expected to rise by one percent as producers respond to extremely positive margins and the lowest corn and meal prices since the 2000 crop for corn, and the 2001 crop for meal. However this fall hog, weights may be little changed from year-previous levels.

The reason is the market factors that are driving large inverses in lean hog futures prices through next May. As of this writing, the October lean futures were over $7 per lean hundredweight premium to the December. This means there is a nearby excess demand in relation to the available supply, but that this extra-demand may wane as the fall progresses. With strong inverses such as these, producers are well advised to send hogs to market as soon as they reach reasonable weights. Thus weights will stay modest as long as the large inverse exists.

Demand Holds Key to Prices

For those of us trying to evaluate prices over the next year we need to be reminded, “It’s Demand–Stupid.” And so it is. The demand side of price seems to hold all of the keys to the extremely strong prices since last spring. Thus, demand is probably the key to how long the price level can persist. So, let’s break down some of the key components of demand and begin the evaluation of its staying power.

The first demand component is increased pork exports and reduced pork imports. In 2004 (trade data is available for January through July), pork exports have been up 24 percent composed of: Japan (+6%); Mexico (70%); and Canada (+28%). The growth in Japan is actually very modest compared to the loss of beef exports there. Mexico on the other hand does seem to be buying much more pork as a substitute for reduced beef purchases.

Canadians, on the other hand, are eating more domestic beef, sending more live hogs to the U.S., and buying more pork cuts from the U.S. Clearly, the increased export demand is related to the reductions (or loss) of beef exports. Imports are down nine percent. Thus in total, net trade has reduced supplies for domestic consumers by about 2.7 percent of commercial production so far in 2004 (data through July).

How big is this impact? Pork production for 2004 through September is up 4.3 percent, subtracting 2.7 percent for net trade leaves domestic pork supplies up by about 1.6 percent. Then subtracting one percent for population growth leaves per capita available domestic pork supplies at up only .6 percent. So, available domestic pork supplies per capita are only modestly higher, but live hog prices have averaged $51.74 so far this year compared to $39.45 for 2003. Prices over $12 per live hundredweight seem to say domestic demand is much better. But read on!

Breaking down the $12 per live hundredweight shows that about one-half of this increase is related to higher retail pork prices (better demand), but the other half is due to smaller retail and packer margins. The higher retail price is partially accounted for by record high beef prices and the substitution of pork for beef. Lower marketing margins at the retail level appear to be partially related to very high marketing margins on beef.

In essence, it appears that retailers are enjoying extraordinary margins on beef and are thus willing to take smaller margins on pork. Pork is also likely being strongly featured by retailers as a more moderate priced alternative to beef. These features tend to move much larger volumes. (Note: The marketing margins I am using here are calculated from retail meat prices collected by the Bureau of Labor Statistics. There is concern that these meat prices do not adequately reflect actual prices. USDA is providing scanner data that may help better understand actual retail prices. Their data and a discussion is available at: http://www.ers.usda.gov/Data/Meatscanner/

Granted, it’s complicated, but will demand hold over the next year? An agreement with Japan on BSE testing standards and how to determine the age of animals would be the first step in widely opening beef exports. Even when this is done, it is not clear how quickly live cattle will be allowed to come in from Canada. If Japan begins to import U.S. beef with the Canadian border remaining closed, cattle and beef prices will move sharply higher, pork exports will drop.

Under this scenario, live hog prices might be $1 to $3 lower. Alternatively, say the Japanese agreement is completed and the Canadian border is opened at the same time. Increased beef exports may be fairly closely offset by increased supplies of Canadian live cattle. If so, cattle and beef prices would be little changed and the impact on live hog prices would be negligible.

On the domestic demand front, beef prices will remain high over the coming year baring another case of BSE in the U.S. This should provide strong support for high retail pork prices. However, there is a question of whether the current narrow pork marketing margins will be maintained. Some widening probably can be expected, but my guess is that they will remain overall favorable over most of the next year. So, I think this continues to support hog prices staying stronger than most would anticipate.

High Hog Prices and Lower Costs

Hog prices seem to be getting increasingly difficult to accurately predict. So as you consider my predictions, keep a “grain of salt” handy. Hog prices as measured by 51% to 52% lean hog carcasses on a live weight basis are expected to average in the higher $40 for the final quarter of 2004. Winter prices are expected to be about $1 less. Spring prices are expected to rally to average in the very low $50s, before summer average prices are once again in the higher $40s, (See Table 5) . Spring and early summer prices are expected to be strong, but growing pork supplies could begin to trim prices by late summer and especially into the fall of 2005 and 2006.

While pork demand is the primary reason for stronger than expected hog prices, it is the large U.S. crops that producers can also thank for a rosy profit outlook. My estimates of costs of production reached $48.50 per live hundredweight in the second quarter of 2004 when U.S. average corn prices were $2.85 and Decatur, Illinois hi-protein meal averaged $333 per ton. This fall, costs estimates are about $38 with estimated last quarter corn prices at $1.90 per bushel and meal at $160 per ton. Over the next 12 months costs are estimated at $39 compared to $44.50 over the past 12 months.

Given estimates for hog prices in Table 5. The period from the spring of 2004 through the summer of 2005 will be a very profitable period. Last spring, high hog prices carried the industry to profits of about $6 per live hundredweight. In the summer, high hog prices and moderating costs resulted in an estimated profit of $14 per live hundredweight. This fall those profits are expected to be around $9, followed by $10 in the winter, $12 next spring, and $7 next summer. A chart of these estimated returns is shown in Figure 1.

Implications for the Industry and the Coming Expansion

It has been a while since pork producers had to worry about income tax liability, but 2004 and 2005 are two of those years. Estimated profits above all costs for 2004 are estimated at $7.60 per live hundredweight, or about $20,000 of net income per 1,000 hogs produced. For 2005, those profits are estimated at $8.25 per live hundredweight or about $22,000 per 1,000 hogs produced. Who receives these returns will of course depend upon which phase of production each individual is involved in, and which party bears most of the price risk.

The positive returns will help operations make progress on improving their financial position. This is especially important since during the period from October of 2001 through March of 2004 producers experienced a loss that averaged $2.20 per live hundredweight. The most severe losses were in late 2002 and early 2003 when they averaged more than $6.00. Some increased their debt load during this period and thus the extended period of profits upcoming will enable them to reduce debt to more manageable levels.

The next issue is feed purchase strategies. Soybean meal futures are currently $150 to $160 per ton. This is cheap by historical standards. Nearby futures prices at $150 per ton or lower have existed only about 15 percent of the time in the past 20 years. But history shows meal futures prices have moved lower, to near $120 per ton, in three of the last 20 years.

Those were 1985, 1998, and 1999. While nearby futures did go as low as $120 per ton (only $122.80 in 1998), the average cash price at Decatur, Illinois for the marketing year was: $166, $139, and $168. For comparison, the U.S. average soybean prices in those three years averaged $5.05, $4.93, and $4.63 per bushel. So, the possibility of lower prices does exist for meal, but that may not occur unless the South American crop is anticipated to be very large. A general strategy would be to purchase your entire fall meal needs and a portion of needs for January to August 2005. A follow-up decision can then be made in the winter as the size of the South American crop becomes better known.

Cash corn prices are depressed by both a large U.S. crop and by weak local basis levels in high yield areas. Owning as much cash inventory at harvest as possible appears to be the favored strategy. I would expect price recovery after harvest from a basis boost in the late-harvest period, by growing usage during the winter, and by anticipation of a much smaller crop in 2005, as well as for tightening anticipated ending stocks from the 2005 crop. Once the maximum cash inventory is purchased, then owning futures would be the preferred choice. A secondary choice that would leave downside price movement opportunity in place would be to buy at-the-money March call options for about 10 cents per bushel.

A note of caution is in order for purchases of feed ingredients. Every buyer wants to purchaser at the lowest prices. However, it is very easy to overstay a position waiting for the last few cents. Keep in mind that corn and meal are both at historic levels that should be considered “good buys” so don’t let meal go up $50 per ton while you are waiting on $5 lower prices.

Finally, how much expansion will be forthcoming in the next year. I think it is going to be fairly robust, at least the largest expansion in the U.S. since 1997 and 1998 when annual U.S. farrowings rose by eight percent. I would expect expansion in the range of four to eight percent over the coming year and one-half. That expansion should begin in earnest this fall and winter and extend through out all of 2005. If so, resulting larger farrowings would begin to show up in the spring of 2005 and extend through mid-2006. Finally, the resulting build-up in slaughter hogs would start in the fall of 2005 and reach peak production in the last-half of 2006.

By these rough cycle measures, hog prices will be strong through the summer of 2005, begin their downward spiral in the fall of 2005 through all of 2006. The worst of the prices on the next cycle could be in late 2006 and early 2007. On a calendar year notation, 2004 and 2005 will be very good price years, then 2006 and 2007 will be poor price years. Generally it is the first of the poor price years that is the worst (2006) with improvement coming by the last-half of the second year (2007).

Historically, the hog industry has continued to revolve around the four year cycle. Below is a rough count of recent years, and also shows how low prices in 2006 and 2007 would fit the four year pattern. Keep in mind that cycles tend to show patterns over time, but that many factors can distort the exact timing such as drought, trade policies, diseases such as BSE, etc. So, studying hog cycles is of value, but should be used as a potential general indicator rather than a precise time line for management decisions.

Good Price Years Bad Price Years
1992 1993 1994 1995
1996 1997 1998 1999
2000 2001 2002 2003
2004 2005 2006 2007




Source: Farm.Doc - October 2004