CME: What Determines Value of Market Animals?

US - What determines the value of a market animal? We all know that the answer to that question could fill volumes, depending on the level of detail one wants to use, write Steve Meyer and Len Steiner.
calendar icon 26 August 2010
clock icon 4 minute read

Costs, supply, productivity, demand, processing costs, the level of competition in the market on a given day. All of those factors plus many more contribute to the value of a market animal.

Research has shown that most of those factors come to play in determining, primarily, the values of meat cuts at the wholesale level. It is where consumers’ tastes, preferences and income/ expenditures come to play through the actions of retailers, foodservice operators and exporters — the people who interact directly with those consumers. It is also where the packer — the person who interacts directly with the producers — exerts the forces coming from the supply side of the market.

So just how related are market animal prices to wholesale prices? The answer, as can be seen in the charts below, is “Very much!“

The top chart shows the relationship of weekly average cattle prices to the weekly average cutout value plus weekly average byproduct value from 1998 through 2009. Cattle prices are weighted averages of steer and heifer prices, both live and dressed stated on a carcass basis. The cutout value is the weighted average cutout value for Choice and Select grade beef.

The fitted line (in this case a third degree polynomial) says that the cutout plus by-product value explains 94.2 per cent of the variation in cattle prices over this time period. We have inserted the 45° line to represent the point at which the animal price would equal the value of the carcass plus the by-products. So — the horizontal difference between the 45° line and any data point would represent the packers’ average gross margin for any given week. The horizontal difference between the 45° line and the regression line would represent an estimate of the packers’ average margins at any given cutout + byproduct value or, if one reads off the vertical axis, any weighted average feedlot price.

Note that beef packers gross margins tend to get lower when prices are lower (ie. supplies are high) and get very wide when prices are high (ie supplies are low. We think the reason for this relationship is that there has been significant excess capacity in beef packing. Large supplies allow better plant utilization and drive down per-unit processing costs, allowing packers to pay more for cattle relative to their wholesale value. Tight supplies push packers’ per-unit costs very high, causing them to reduce cattle bids relative to output value.

The hog chart relates weekly average Iowa-Minnesota barrow and gilt prices to USDA’s 51-52 per cent cutout value plus the value of by-products. Note that we did delete 13 observations that had hog prices below $30 from this graph just to make it easier to read. Eleven of those were for weeks from October 1998 to January 1999 during the hog supply vs. packing capacity mismatch of that fall. All observations were included in the regression calculation whose logarithmic function explains 92.9 per cent of the variation in hog prices. The relationship of the regression line and the 45° line is quite different for hogs. We think the reason is that the pork packing sector has been much more correctly sized relative to supplies during the time period in question. Pork packers’ margins grow when supplies are large and prices are low because they are running at or very near capacity. This means that marginal processing costs (change in total costs per unit change in throughput) are high because throughput can be increased by only small amounts. Expected packer margins are relatively stable at all other price levels, increasing only slightly at high values when supplies are likely very tight.

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