Market Preview: Profits are Not a Pipe Dream

by 5m Editor
8 February 2011, at 10:23am

US - In this week's Market Preview from National Hog Farmer magazine, Steve Meyer discusses profits.

You can make $30/head. Sounds like a pipe dream with cash corn over $6.55/bu. in Omaha and corn futures bumping $7/bu. on the July contract. Add in cash soybean meal over $370, basis Illinois and meal futures near $390 and the mountain just gets higher. But Friday’s futures markets would allow producers whose production parameters match those of average Iowa farrow-to-finish operations (Figure 1; according to Shane Ellis and colleagues at Iowa State University’s [ISU] Department of Economics) to lock in profits of $29.82/head for pigs to be sold in May.

Granted, it’s not exactly $30 and it’s only for one month, but my point is that things are certainly not all gloom and doom. Friday’s corn, soybean and Lean Hogs (LH) futures prices would give ISU’s average farrow-to-finish operation an average profit of $7.20/head for 2011. Again, it’s not the $22 and $25/head received in 2004 and 2005, but it is a far cry from the losses of $22 and $26/head in 2008 and 2009. And, it is much closer to last year’s $10.29/head than we have been since last summer!

I don’t like the cost situation we are in any better than any of you do. I still think it is contrived and unfair. But as I have written in the past, it is what it is and professionals must deal with the world as it is instead of as they would like it to be.

And the world we are dealing with now could be a lot worse. Chicago Mercantile Exchange (CME) Lean Hogs futures set new records again last week with the June contract trading at nearly $101/cwt., carcass. Further, that trade isn’t a “year-ahead“ pipe dream like it was the first time we touched $100/cwt. back in 2008. This one is close enough at hand that we have real supply data, can see what our competition is likely to do, and can observe demand conditions in the marketplace. We actually have some data for June 2011, and the market says $100 hogs are a possibility.

Futures Markets for Real

Futures markets are more than predictions of future prices. The prices you see quoted today are actually offers from a buyer that are accepted by a seller. Yes, they are for future delivery, but they are price offers nonetheless. And since futures prices in the delivery period are correlated with cash prices, they constitute a price that you can “lock in“ subject to the variability of the price basis – the difference between futures and cash prices – during that delivery period.

Is the basis right? Is it fair? The answers do not matter. Don’t get hung up on them. After allowing for the “normal“ basis of the past, is the price good enough to provide you with an acceptable profit? That is the only question that matters.

Might profits be larger in this summer’s cash market? That is certainly a possibility and, in fact, the trend of LH futures prices at present suggests that “the market“ has yet to run out of steam. But the point is that the markets are offering profits and producers must be prepared to act when the profits offered are a) large enough to provide a good, yet reasonable, return on capital, and b) possibly the best they are going to get given current information.

Be Prepared

Have you thought about what those levels are for each month of 2011? Do you have a written plan for making such decisions? Do you have the data necessary to make an informed decision? Have you talked to your lender about the capital that such a decision may require? If not, then you are not, in my opinion, ready to handle the levels of risk that will be posed to you over the coming years.

There are a lot of things that I do not like about the current market situation. But most of them are completely out of my control. I think the same applies to many of you. It is difficult to focus on the things you can control when you see these “outside factors“ day in and day out. The difficulty increases when our emotions get involved. But focusing on what you can control is critical at the present time.

You are deciding every day whether to accept or reject a bona-fide offer for every hog you will sell this year. The price is not precise due to basis uncertainty, but basis risk is still smaller than price risk and that is the value of a futures market for producers.