Tag Archives: meats

Profitability vs. Responsibility in the Cattle Market

We’ve discussed at length the balance between feeding a growing population in a world of declining resources. These discussions have been primarily focused on the grain markets and the enhanced yields of genetically modified organisms (GMO) versus any applicable health and environmental risks. This week, we’ll focus on a major development within the cattle industry as it tries to balance concern for public and animal well being against the dual mandate of feeding the world while generating some profit.

Tyson Foods unexpectedly announced that they were going to stop buying cattle from feedlots that use Zilmax on August 7th. Zilmax is the brand name of Merck’s beta-agonist feed supplement. The FDA originally approved beta-agonists for the treatment of asthma in humans. One of the noted side effects during the drug’s development was consistently muscular weight gain in treated mice. Merck used this as an opportunity to expand their animal care services and received FDA approval of Zilmax in 2006 for use in cattle. The entire beta-agonist family has received various approvals as a feed additive since 1999.

There is no doubt that cattle fed beta-agonists gain weight quickly. The cattle production cycle typically sends cattle to feed lots for, “finishing” before being sent to slaughter or, “processing” in today’s politically, correct terminology. This is where feed additives come into play and the final pounds are added on. Kansas State has a widely respected animal husbandry division and their published research clearly shows that feedlot animals have grown much larger and more quickly than they have in the past. Cattle are gaining more weight per day than ever and are spending less time on the feedlots. The feedlots, in turn are sending heavier animals to slaughter. The result is that the U.S. is producing nearly 20% more meat from nearly 20% fewer animals.

Tyson’s concern is based on the health of the animals being delivered to their processing facilities. We all remember the video clips on the news during the mad cow scare. These included disturbing images of animals unable to walk or shaking with tremors. That is a neurological disorder. The current issue is strictly physiological. Animals are becoming so large, so quickly that their bodies are shutting down as they try to support the dramatically rapid increase in mass. Dr. Bryan McMurry states that cattle now average 1,350 pounds and have gained 300 pounds over the last 30 years. His primary concern is that 1,350 pounds is now the average, which means over half the animals are larger and the first standard deviation places 16% of the animals above 1,500 pounds. His analysis shows that these animals aren’t even able to reproduce effectively through lower calf weights and lighter weaning weights. The animals simply require too much of their bodies effort to sustain themselves and therefore don’t have enough in reserve to foster healthy calves.

Our society is constantly debating the battles between science and morality. We’ve grown faster technologically than we have ethically. Revenues drive research. Morality is not a revenue producer. Tyson’s announcement that they will not accept Zilmax fed cattle after September 6th is a major statement considering they control 25% of the meat industry.  However, they are a publically traded company and need to continue turning a profit. Therefore, they will still accept animals fed Ractopamine and Optaflexx made by Eli Lilly. Neither of these compounds has been as effective as Zilmax, which has been banned in over 100 countries but both are better financial alternatives to longer finishing times and lower weights.

The financial implications on the cattle futures market have been a chaotic glimpse into the dichotomy of public speculative action versus the cooler heads of commercial traders. Initially, the market rocketed to limit up. Speculative buying on the idea that the largest packer in the U.S. would have to buy more cattle at lighter weights going forward fueled this. The secondary reaction brought the market back to unchanged and lower as it digested the fact that there will be an initial glut of cattle coming to market to beat the September 6th deadline. Commercial traders meanwhile have been light buyers over the last week. I felt the important thing was to wait on commercial reaction to the news. This meant I had to wait for this week’s Commitment of Traders report.

The math behind lighter cattle means that another 90 million bushels of corn will have to be dedicated towards animal feed rather than ethanol or other crops or development land. We will also need to add about 10 million more cattle to the production chain to make up for lighter weights. That represents an increase of more than 10%. The balancing act comes down to the environmental strains of producing another 10 million animals and growing another 90 million bushels of corn against as well as higher processing costs at the slaughterhouses and extra finishing time at the feedlots versus profitability. This will lead to higher prices down the road in spite of a short-term glut of animals coming to market.

Hog Futures About Face

Trading is always a measured risk and best guess scenario. We use the tools and information we have access to in an attempt to predict future market direction and magnitude. This must be balanced against the risk and then the odds, along with the risk and reward scenario must be calculated to determine if the trade is worth taking. Every once in a great while multiple forces align themselves and make the task of calculating variables much easier. This is the current situation in the lean hog futures where fundamental, technical and seasonal factors have all combined to put a halt on this market’s rally and set the market up for a profitable short position based on declining hog prices over the next two weeks.Trades lasting more than a day or two require a proper assessment of the lay of the land. This means starting with the fundamentals. The greatest fundamental impacts on hog prices are the price of corn and Chinese demand. The high price of corn over the 2012 crop year did cause breeding sow numbers to decline. However the increase in hog prices due to Chinese demand was enough to allow farmers to hold on to breeding sows that in normal years would’ve been sent to liquidation. Research from Purdue University showed that, “increased lean hog prices combined with lower feed costs have translated into reduced losses of about $30 per head – about 40 percent coming from the lower feed prices and 60 percent from higher lean hog futures.”The equation of measuring herd sizes, slaughter rates and feed prices is better left to the professionals and universities. The end result of their analysis is their actions in the markets. Tracking their buying and selling as well as their magnitude provides a single variable that can be measured against price. This simplified equation of the degree of commercial trader buying or selling relative to the current market price can be tracked through the Commitment of Traders Reports published weekly by the Commodity Futures Trading Commission. Commercial traders have sold more than 20,000 hog futures contracts since the end of September. Clearly, the commercial traders see their market as currently over-valued.Seasonally, hogs are coming into their weakest period of the year. Hogs tend to slow down in the heat of summer. They feed less. They breed less and their prices tend to rise. Moore Research has shown that hog prices tend to decline dramatically during the first two weeks of December. This follows the end of summer and the expiration of consumer demand once the packers have stocked the stores for the Holidays. Moore Research has shown that hog prices have declined during the first two weeks of December in each of the last 15 years by an average of 4.15% for an average profit of $935 per contract. Their numbers provide an estimated target of 82.45 in the February lean hog futures while the average ending price provides an outside target of 60.00. Perhaps a weighted average is a better yardstick due to the structural change in the Chinese demand growth. This makes 74.50 a more likely outside target.Technically speaking, the hog market set itself up for a perfect reversal. The hog market has rallied nearly 15% since making the September lows and spent most of last week churning near the highs. Monday’s trade brought an outside bar along with a close in the bottom 10% of the day’s range. Psychologically, this meant that the market tried to move higher and couldn’t which resulted selling pressure as weak longs were flushed out of the market once it breached its lows from the previous week. The close in the bottom 10% of the range after an outside day is a textbook reversal pattern from the Larry Connors book, Street Smarts. Linda Raschke, a well-known trader specializing in quantitative analysis, developed this strategy. This forecasts lower prices ahead based on her work.The markets rarely provide traders with this many clues to future direction or opportunity. Frankly, traders with enough experience may simply consider this a very well baited trap. Therefore, risk controls must always be put in place. There’s no telling when a seasonal pattern may not hold true and there’s no point wasting years’ profits on stubbornness. Protective buy stops will be placed above the reversal bar’s high at 87.775. Profits will be taken at a minimum target of 82.45 the average decline or, December 18th, the end of the seasonal weakness.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Third Stage Growth in Agri-Business

The run up in food prices this year has, hopefully, shined a bright light on the oligopoly that controls the world’s grain markets. An oligopoly is a market that is controlled by a small number of producers, which allows them to collaborate and set prices for the market as a whole. OPEC is the most common textbook example. The U.S., Brazil, Argentina and Australia dominate the grain industry. There is grain production in every country but these four control the vast majority of the export market. That may be about to change and bring new, long-term investment possibilities with it.

When crude oil topped $145 per barrel in 2008 it was a painful, but simple adjustment to the world’s lifestyle. When the grain market soared to all time highs this summer, forcing food inflation on the world’s population, the adjustments weren’t so simple. The mechanization of the global grain production process places more and more of the world’s food production in the hands of fewer and fewer people.

The global grain stores are running at multi year lows, just as they were at the beginning of this U.S. growing season. This summer’s drought was the worst in 50 years here. The weather pattern also knocked 13% off of Australia’s wheat crop and they’re the world’s largest wheat exporter. This also led to a nearly 60% decline in their ending stocks over the last three years. The only thing keeping prices in check at the moment is South America’s increasing efficiency. Brazil’s soy production may surpass the U.S. this year and thanks to their long growing season, double crops of corn are becoming normal.

The global demand growth for coarse grain production has been fueled by the Pacific Rim’s meat production industry, rather than by population growth. China’s population growth is less than one percent per year, yet their hog market is growing by an average of 3.5% per year. The growth in their agricultural markets for both grains and meats has been astounding, as production of both have shifted from individual farmers on their own land to the mechanized version of agri-business that is the model of the industrial world. Their soybean imports, which are used for feed, have grown from 3 million metric tons in 1997 to approximately 56 million tons this year.

These wheels have been set in motion and will not be derailed by a collapse in the Eurozone or a surprise in our elections. The trends in population growth and the move towards global improvements in diet are really just beginning. The United Nations and the Food and Agriculture Organization (FAO) just reported that global wheat prices for 2012 were up 25%. They added further that source inputs have now caused the price of dairy to rise by 7% in just the last month.

The arguments over who gets their principal back on a Greek or Spanish Bond is far less important to Greeks and Italians than the ability to put food on the table. Food inflation, as a result of the commodity rallies of ’07 and ’12, was also a primary cause of the Arab Spring. It is far easier to control a population with a full belly than it is to placate a parent unable to stop the crying of a hungry child.

So, where’s the trade? The trade starts with slowing global growth and negative growth across Europe. Negative growth will increasingly put the pinch on Eastern European countries like Kazakhstan, Ukraine and Russia. This is the main breadbasket of Europe and North Africa. Bottom up analysis of these macro trends reveals very large growth potential in several African countries. The BRIC’s have received most of the attention over the last ten years and rightfully so. However, as more and more resources are pulled from African countries for global production, it becomes clear that these countries are also next on the open borders list to develop.

Therefore, using the pending global economic contraction as the setup, I’ll be using declines in the stock market to knock the valuations of agri-business stocks like ADM, Monsanto, Cargill, AgroSA, Bunge, Caterpillar, DeutzAG, down and for retail investors to get washed out. There are two important things to take away from this. First of all, I am not a stockbroker. These trades cannot be executed through me. I stand to gain nothing financially from anyone following this advice. Secondly, I believe that we will get an equity selloff similar to 2008 and I plan on being ready to put cash to work in companies that stand to profit the most from the commodity markets I know best in the coming decade.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.