For the last two to three months sow slaughter and gilt retention numbers were not supporting the expected reduction and now the most recent Hogs and Pigs report helps to confirm no significant decline in inventories. USDA released the Quarterly Hogs and Pigs report December 28 with estimates of December 1 inventories.

Much discussion leading up to the report called for a decline in inventory numbers as a result of this year’s cost levels and significant red ink. Somewhat surprising to many, was that the report told us that the reduction has been very minimal and actually there has been a little bit of expansion of the breeding herd. For the last two to three months sow slaughter and gilt retention numbers were not supporting the expected reduction and now the most recent Hogs and Pigs report helps to confirm no significant decline in inventories.

Table 1 is a summary of the December 1, 2012 estimates. The national hog and pig inventory, at 66.3 million head, was only 0.02 percent less than a year ago. Breeding herd inventory, at 5.8 million head, was up 0.02 percent and market hog inventory was down 0.04 percent at 60.5 million head. Lighter classes of market hogs were about at par with year previous levels. Pigs per litter for Sep-Nov12 at 10.15 was the highest quarterly estimate in history, indicating the productivity train keeps running down the track.

This report included a significant revision to the Mar-May12 sows farrowed (+63,000 head leading to a +2.2% year-over-year increase) and pig crop (+363,000) which makes the Mar-May 2012 pig crop of 30.1 million the highest singular quarterly pig crop in history back to 1973.

Projecting farrowing intentions out with commensurate pigs per litter it looks like the potential is there for a new record high for the Dec12-Feb13 pig crop at 28.9 million head. The Mar-May13 pig crop, with such a big revision to Mar-May12, makes a projection of 29.8 million head slightly below the previous year. Projecting further out it, it looks like the pig crops in 2013 could approach record highs for their individual quarters and possibly a new all-time record high for the Jun-Aug period. The point is these pig crops remain and project to be very large compared to historical levels, record highs in some cases.

Iowa producers increased inventories of the breeding herd and market hogs 2.0% and 3.1%, respectively, over December 1, 2011. This added 20,000 animals to the breeding herd and 580,000 market hogs. The total inventory was 20.6 million head, up 3.0% from the year before and near the record inventory of 20.7 million reported September 1, 2012. Similarly, the 19.57 million market hog estimate, up 3.1% from last December, is only second historically to the September 1, 2012 market inventory of 19.70 million head. Producers in Iowa appear to be ramping up their farrowing plans. Sows farrowed in Sep-Nov were 3.1 percent above year previous levels and farrowing intentions call for 5.3 percent and 5.1 percent increase year-over-year in Dec12- Feb13 and Mar-May13, respectively.

What has occurred that has kept record high feed costs last summer and a big sell off in hog prices in September from extracting a higher toll among hog producers? There are likely two main factors at play. First, there is a good portion of the business that started several years ago actively managing risk and managing margins on a forward contract basis either through the board or with packers and in doing so they managed both sides of the profit equation, costs and hog prices. This practice continues to be carried on by a larger and wider proportion of hog producers and these producers likely avoided (or limited) the losses that cash driven models (cash buying of corn and cash selling of hogs) were predicting for the second half of 2012. As such, many producers may have entered summer and fall in much better financial staying power than what many had expected. Second, hog producers are resilient and periods of low and negative returns followed by profitable conditions are not all too uncommon to many. For instance, 2008-09 was marred by returns to farrow-to-finish production of approximately -$20 per head on average (cash market estimate – ISU Estimated Returns) only to be followed by returns of greater than $26 per head in most of 2010. Moving forward, producers appear to be betting on a decent corn crop in 2013, leading to costs going down, and surviving another year and then thriving into 2014. Everything looks to be on-the-line going into 2013, with hopes of strong exports and significant or very timely rains during the next growing season.

Current inventories and expectations for future supplies have implications for market prices in 2013. What is expected for first quarter hog slaughter and pork supply looks to be currently priced into the market. But, then it looks like no reduction in slaughter levels year-over-year in any of the following three quarters equating to a larger supply than the board has priced in. Lean hog futures contracts closed sharply the first trading day following the report as traders adjusted to the greater pork production potential implied by the December 1 inventory.

Table 2 summarizes price forecasts by quarter. Price forecast are for the Iowa-Southern Minnesota cash price for barrows and gilts and a comparable CME Lean Hog contract price adjusted for Iowa basis. For the spring and summer, hog prices will be back into the mid to high 80’s to low 90’s as hog supplies level off and the general meat market heats up. The ISU model suggests a little more bullish market than the futures are expecting in the fourth quarter of 2013.

With the large amount of risk out there because of the reduction in financial resources and the risk based on the potential for persistence of drought it is important to watch for hedging opportunities. While it is difficult to fully anticipate how a market will respond, this Hogs and Pigs report was seen as bearish, and the market may overreact to the news of more supplies than anticipated by pushing lean hog futures prices lower. With respect to the feed market, to quote my colleague Dr. Chad Hart, “For 2013, I have a good $4 corn story and a good $9 corn story. The problem is that I don’t know which story to tell. Timely rains and a bumper crop (or another bout of recession) would bring significantly lower prices. Continuation of drought would drive 2013 prices higher. The markets for the moment have sort of split the difference between the two stories.“ In light of this uncertainty, if you haven’t already done so, it may be a good time to think about price protection.

Figure 1 is a graph of the computed hog “crush“ margin (http://www.econ.iastate.edu/margins/) based on the close of the futures market on Monday, December 31. Assuming a $40 gross margin is needed to cover overhead and other costs and breakeven, then the road ahead appears to be rough if the current futures prices for hogs, corn, and soybean meal prove to be a true prediction. However, each individual operation may have different pricing for weaned pigs, hogs, corn, and soybean meal, and different feed use and costs that must be covered. Regardless, the crush margin can act as an indicator of hedging opportunities by alerting a producer when futures prices are in the desired range.