Market Preview: Production Adjustments Will Come

by 5m Editor
7 January 2008, at 9:27am

US - Weekly US Market Preview for the week ending 4th January 2008, provided by Steve R. Meyer, PhD, Paragon Economics, Inc.

The rumblings of the past couple of weeks have centered on the question: "How can these hog producers be expanding so much if conditions are as bad as they say?" Or, more pointedly: "Why are those big guys still growing? Are they just trying to push out the little guys?"

There are very good answers to the first question, but probably no answer that will satisfy those posing the second. Regardless, here is my take on what is happening and what might happen as we go through 2008.

First and foremost: "It's the lags!" Sorry, I've been watching way too much football and DLP commercials for those tiny mirrors. Economics is full of time lags, regardless of the assumptions of perfect competition theory. It just takes time for people to make and execute decisions. While that is happening, the changes in economic variables may not make sense.

In fact, history tells us that U.S. producers must see nearly a year of actual losses before the breeding herd begins to decline. Does today's "professional" industry lend itself to quicker decisionmaking and shorter lags or does today's high-investment, fixed-facility industry lend itself to limited decisionmaking opportunities and longer lags? We are about to find out. My guess is that the latter will win out simply because high-tech, high-investment farms represent the vast majority of U.S. output.

So, there should be no surprise that the breeding herd is up while producers are losing money, since the losses really just commenced in October. There is a substantial amount of inertia in this business and it will take awhile to complete the projects already under construction. They will be completed -- unless things get much worse than they are at present.

Second, U.S. producers haven't lost much money -- yet. Cash corn was near $3/bu. in October. Cash soybean meal was near $200/ton in August. Further, producers forward contracted or hedged perhaps more hogs and more feed ingredients than ever before. Those profitable positions mean that not much money has been lost yet, so why would anyone think that a contraction would be underway?

Third, and I really hate to say this, but U.S. producers will very likely wait to see what happens in Canada. The economic situation there is much worse and has been so for much longer. Something has to give and it is very logical that U.S. producers will stall any cutbacks to see if the reduction of Canada's herd will be enough to turn things around.

For that to happen, the Canadian reductions will have to be large. A 4% reduction in Canada would offset the roughly 1% growth of the U.S. herd over the past few quarters. If we need to pull slaughter back from +10% (December's increase) to just +5%, and productivity growth levels off, that would imply a 20% reduction in Canada -- if the Canadians do all of the cutting. While shocking, I have actually heard that number mentioned by some Canadian observers.

Finally, while feed ingredient futures continue to climb, Chicago Mercantile Exchange (CME) Lean Hogs futures were still quite encouraging until the past few weeks. Every contract through July has hit contract-life lows since the USDA report was released and the average price for all 2008 contracts now stands below $68 -- lower than the projected breakeven price of $70 mentioned by Iowa State agricultural economist John Lawrence during last week's National Pork Board roundtable discussion of the Hogs & Pigs Report.

The industry will adjust, but it will take time. The adjustment will begin in Canada, but I doubt the U.S. industry will go unscathed. The prospect of a difficult 2008 is very, very real.

NOTE: The Canadian data in this week's Prices and Production tables are for the week of Dec. 15. Those are the most recent available from Statistics Canada.

5m Editor