Last week's big slaughter run (1.954 million head, 4.5% larger than one year ago) and this week's romping first three days (1.088 million head, 7.7% larger than the same three days last year) have us wondering if the expected increase in output, which has never shown up in USDA inventory reports, is finally upon us.

Figure 1 shows federally inspected (FI) slaughter levels vs. last year and expected levels for this year. After spending most of May and June at or below both last year's and expected levels, last week's run was among the largest positive year-over-year deviations of the year. Further, somewhat short supplies in May and June and the resulting lower market weights suggest that this surge is not due to hogs being backed up. We are now into the hogs in the 120-179-lb. inventory classification in the June Hogs and Pigs Report. That group was pegged at 0.5% larger than one year ago, yet we are getting these large slaughter runs.

What could be happening? Well, obviously, it could be a problem with the June report -- bad survey responses by producers or an undercount by USDA. I have had some reservations about the pace of this sow herd expansion and, even more so, the apparent reduction in productivity growth that the last few reports have suggested. Until now, there has been little evidence to call those factors into question, and I don't think we have enough evidence yet to draw any real conclusions.

FI Hog Slaughter, Weekly
Based Upon USDA Hogs and Pigs Report, June '06


U.S. Sow Slaughter

Still, logic tells us that after 29 months of profits -- many of them big -- we should get more growth. Yes, I know that past expansions never had to overcome today's legal, environmental and social hurdles, but a lot of money has been made and pork producers have historically never been able to stand prosperity this long.

A second possibility is that the May-June "shortage" was not caused by death losses but by significant reductions in growth rates. That argument sounds plausible until you consider that, if USDA's June numbers were even close to correct, the effect would have to have manifested itself just since mid-May. We've heard talk of porcine circovirus-associated disease (PCVAD) problems in North Carolina and, to a lesser extent, in the Midwest since last winter. However, any slowdown should have had some effect before mid-May, maybe even early enough to show up in the March report.

The conclusion? I don't know yet. It will take some time to sort this out, but it still appears that we will see a seasonal increase in supplies and the concurrent seasonal decline in hog prices. Chicago Mercantile Exchange (CME) Lean Hog futures for October penetrated and closed below the 40-day moving average on Wednesday, while December penetrated the 40-day moving average but managed to close just above it. In early trading on Thursday, October is below both the 40- and 50-day moving averages, while December is below the 40- and barely above the 50-day moving averages. Many traders use the 40- and 50-day moving average as a trigger level for a key reversal.

And it is important to note that this break in the futures has not been driven by a real break in cash hogs. Cash has driven the futures market for most of the summer but, in spite of the large slaughter runs last week and this week, cash prices have held their ground at $69 or so quite well.

Capture the Rally

I have urged producers to sell this summer futures rally for some time and I still think that is a prudent move. Selling hogs in the black in October and December of the fourth year of a hog cycle is a pretty rare occurrence. Know what these prices mean in terms of return on capital and return on equity and take action when those numbers hit your targets.

By the way -- if you sell an equal number of hogs in each of the eight contracts now on the board for the next 12 months, your average futures price would be $62.03 as of Thursday morning. If you sell an equal number of hogs in each calendar month (and thus sell two month's worth in the October, December, February and April contracts), your average futures price would be $61.02. Those have historically been pretty good hog prices, but what will they be with $2.50+ corn?

Who's Selling the Sows?

I'm also scratching my head about the surge in U.S. sow slaughter over the past few months. Profits, profits, profits and we are slaughtering significantly more sows than last year. And it is not due to imports from Canada - those are up only 1%, year-to-date, and have actually been lower than last year for 11 of the past 12 weeks.

The most plausible explanation is that a number of operations are doing depops-repops while sow and market hog prices are still good and before an expected increase in feed prices. I know of a couple of operations doing that back in May, but have no firsthand knowledge of such during this most recent increase.

University of Missouri data show that gilt retention since late April has not been near large enough to offset this increase in sow slaughter. It is possible that the spring price dips (remember that some hogs were sold for losses back in April) and concern over fall markets may have driven part of this reduction. The end effect may well be even slower expansion than we have already seen -- and that could be very good for those who remain.