Market Preview: What the Future May Hold

by 5m Editor
28 October 2006, at 3:12pm

US - Weekly U.S. Market Preview w/e 27th October, provided by Steve R. Meyer, Ph.D., Paragon Economics, Inc.

While the end of October is certainly not a traditional "review where I am in life" time of year, I still thought it might be good to take stock of where the pork industry is at present. Many changes are afoot and pork producers in both the United States and Canada are going to have to make some important decisions to cope with them.

Here is my list of key factors:

The highest feed prices since 1996 and, more important, the fact that these feed price increases will be persistent if not permanent. In '96 and preceding years, high feed prices were supply driven (i.e. the result of a short grain crop), and we pretty well knew that the next year's bumper crop would rectify the situation. Not so this time!

While a short U.S. wheat crop and drought conditions in Southern Hemisphere wheat-producing countries triggered this early explosion in corn prices, corn prices were going up regardless and the subsidy-driven, and potentially mandate-driven, U.S. appetite for ethanol is destined to keep them high by historical standards. What can you do? Not much in the short run as this ship has sailed -- early. But this environment is likely to change the variance in corn prices as well as the average simply because the corn usage plateau will be higher, thus creating a more likely and more critical mismatch between supply and usage in the case of a short crop.

U.S. exports are growing, but they are doing so at a slower pace, while Canada's exports are actually down through August compared to last year. I think this slowing growth was inevitable simply due to the numbers involved. It wasn't too difficult to push 20% more product overseas when we were shipping one billion pounds. But the incremental tonnage to achieve 20% growth on a base of two billion pounds is a chunk!

The United States and Canada are still in a very strong competitive position to supply high-quality, wholesome pork to the world and will remain so unless the corn situation causes the United States to become a corn importer. If that happens, U.S. corn basis vs. the world price changes from transportation costs "under" to transportation costs "over" and the United States and Canadian feed cost advantage to international competitors will be gone. It's a long shot, but not impossible.

A plateau in domestic U.S. meat consumption (and potentially falling) could mean much more competition for a pie that is, at best, no larger than before. This is not the first time that consumption has reached a speculated saturation point. But the data and the apparent consumer sentiments favoring smaller portions, less intake, less obesity, etc. appear to be more liable to make the plateau last this time.

Ample packing capacity in the United States, but possibly lower capacity in Canada. While Canadian capacity is important, it is the U.S. number that is critical since the U.S. hog market sets price for both countries. U.S. daily slaughter has routinely exceeded 410,000 head this fall with a record actual run of 419,151 on Sept. 12, and a record estimated run of 423,000 on Tuesday of this week. And, there is more capacity on the way as Triumph Foods still plans another plant for western Illinois. The U.S-Canadian exchange rate will continue to force Canadian pigs to the United States for feeding and, thus, keep Canadian packers in a difficult supply situation, not to mention difficulties with labor in the prairie provinces.

Higher building costs have been a key factor in the slow growth of the U.S. herd after 32 straight months of profits. I think they will continue to make producers think twice before building. This factor, along with regulatory hurdles, will keep the pace of production response low and be supportive to hog prices.

My list is certainly not comprehensive and I'm sure North American Preview readers can come up with several more key factors. But these underscore the different environment that producers face today and in the future. Hopefully, they will serve as a stimulus for creative thinking.

Prices Hanging in There

Cash hog prices have hung tough in the $63 to $65 range the past four weeks while Chicago Mercantile Exchange (CME) Lean Hogs futures have risen (see Figure 1). The April through October 2007 contracts all set contract life highs on Wednesday.

June '07 Lean Hogs futures eclipsed $70 for the first time and the simple average of all of the contracts on the board (Dec. '06 through Dec. '07) was $64.80 at Wednesday's close. For comparison, the average national total net price thus far in 2006 has been $64.50 (includes contracted hogs). The average for the same price series and time period in 2005 was $69.06.

What's the point? There are actually two:

Hog prices have been remarkably stable and profitable during a period when we were expecting to make (and may have made) a cyclical low, and

Futures prices are providing opportunities for producers to lock in a continuation of these relatively good, stable prices.

The real question, of course, is whether $65/cwt. carcass will be enough to provide acceptable profits in a world with corn priced at $3/bu. or more.

5m Editor