Market Preview: 'Your' Basis Level Really Counts

by 5m Editor
6 December 2011, at 4:53am

US - With Thanksgiving past, Christmas near, and the New Year fast approaching, many producers will be thinking about the trials and blessings that have come their way this year, writes Steve Meyer in his "Market Preview" featured in National Hog Farmer magazine.

Recent market developments have brought some big blessings. Most notable are the changes in feed ingredient and hog prices that have driven a dramatic increase in potential profits for 2012. Figure 1 shows my latest computations using Iowa State University's production parameters for average farrow-to-finish operations and Chicago Mercantile Exchange (CME) Groups closing futures prices for Friday, 3 December.

Readers should note that the profit figures for both 2011 and 2012 are $2-3 higher than I have computed in the past due to a change in hog basis computations. The numbers shown here reflect the weekly basis for the national negotiated slaughter net price. I have not used that series in the past, but with nine years of data, I believe it is appropriate for computing expected net prices for spot-sold pigs.

Projected Iowa corn prices of less than $6/bu. and soybean meal prices under $300/ton have put forecasted production costs at their lowest level since 2010. While $81/cwt., carcass, is by no means low, it is roughly $15/cwt. lower than the grain futures markets were offering last summer.

The real question is whether there is much bottom side potential left in this market. Slower-than-expected corn exports, projected declines of cattle and chicken numbers, a stronger US dollar and larger world wheat supplies have all pressured corn. Is there any pressure left to come to bear? I think it is limited, given the projected carryout stocks. Soybean meal will depend on the South American crop, the soybean oil market and, of course, the pending battle for crop acres in the United States.

The real reason $81/cwt. costs look good, though, is Lean Hogs futures in the $90s, with some trades above $100, in the past few weeks. Those 2010 costs of roughly $70/cwt., carcass, applied to hogs that sold on an $80 market; 2012 hogs are now forecast to be just over $90/cwt., carcass. Current futures prices are offering substantially better margins - even for average producers. If your costs are lower than $90/cwt., carcass, or if you have done a great job of pricing pigs, you could well be better off.

Historic Basis Levels

My basis change suggested that a look at historic basis levels may be useful (Figure 2). Basis is simply the difference between two price series. In the case of hogs, the relevant series are the Lean Hogs futures contract and cash hogs, but the choice of that cash series is important. Figure 2 shows five different cash series - the CME Lean Hogs index, the national negotiated prior day NET price, and the national, western Corn Belt and eastern Corn Belt negotiated BASE prices.

It is easy to see that all are highly correlated and quite seasonal. It is also apparent that the largest basis levels, whether positive or negative, occur in months that do not have futures contracts. The absence of contracts for four months causes timing mismatches in that a current cash market for, say late December is being compared to a futures price for mid-February. Anyone trading February Lean Hogs futures is betting on the price the last two days that the contract is traded, so the February contract does not readily respond to a cash market that is two months away in terms of time. Thus, the late-December and early-January basis levels are large.

Regardless of what you think of these basis depictions, you need to realize that I do not have the most important one on this chart - YOURS! All I have to work with are the prices published by USDA. Your bid on any given day may not be very close to these weighted average prices. Further, I cannot get the prices that all (or any, for that matter) of our readers see, even if I were to call the packers every day. The reason, of course, is that the packers know I have nothing to sell and are not inclined to treat me as a supplier.

Therefore, you need to keep track of your basis and the transportation costs that will further impact the difference you might see between your realized price and those reported by USDA or traded every day at the CME. It's a chore. But if you want to make accurate pricing decisions, the basis levels shown in Figure 2 are just a guide. Your basis levels are what really count.

To view the graphs, please click here.