CME: Futures Speculation Lowers Pressured Prices

30 November 2011, at 5:52am

US - Global investors started yet another Monday full of optimism that maybe, just maybe, this is going to be the week when European politicians finally find their way out of the maze that has become the Euro Zone, write Steve Meyer and Len Steiner.

Grain and livestock futures were buoyed by the action in outside markets. However, the early optimism was tempered later in the day by the realisation that some of the measures proposed smack of desperation rather than a long term strategy befitting the largest economy in the world (European Union).

It does appear that the crisis is approaching the end game, possibly in the next two weeks. It is an issue worth keeping an eye on as it could have a significant short term impact on futures markets going into year end.

Lean hog futures were one of the few contracts that lost ground on Monday, with prices pressured lower by speculation that current out front futures may have run too far ahead of wholesale pork values.

The biggest declines came in the February and April contracts, which lost 122 and 127 points respectively. Futures are currently pricing hogs for the winter and early spring at $90- $92 per cwt, an eight to 10 per cent premium over current cash hog values. This is pretty much in line with historical precedent.

In the last five years, the average premium of hog values during January - April has been about nine per cent over November prices. The problem, however, is that as we get to ever higher price levels, the normal seasonal increases become harder to achieve.

Indeed, the reason why we see this kind of premium from Q4 of this year to Q1 of the following year is because pork prices tend to decline sharply in Q4.

That did not happen this year, with the cutout currently priced at the same level as it was back in March of 2011.

As the chart below shows, even with great export demand earlier in the year, the pork cutout did not break over $95/cwt until April of 2011.

In order to justify current hog futures in the low 90s, the pork cutout will likely need to be close to $100/cwt by February or March. And you get to that kind of price either via even stronger export sales or a sharp downward correction in supply.

Which brings us to the two main issues facing the market for the next three to six months. First, exports need to continue to expand. But for that to happen, you need stable currency markets (the Euro issue has not helped here) and you need an expanding world economy (recession in Europe could again be detrimental).

The second issue is that of supply. Hog weights are currently running above year ago levels and the break in corn prices could lead producers to keep their foot on the gas pedal and continue to bring heavier hogs to market through next year.

Producers may not be increasing the herd but they are finding ways to produce more pork. It will be nervous trading between now and Easter.