Weekly Purcell Agricultural Commodity Market Report
Wayne D. Purcell
Agricultural and Applied Economics
Virginia Tech
October 21, 2003
Since we are approaching the time that we will building the beef cow herd again, it is important that producers and decision makers understand the "why" of the huge run-up in prices we have seen across the past three months. There are some around the country arguing that these prices are due to very strong demand, but that posture is incorrect. Cattle prices have run as high as $110 in recent days. At the same time we have seen a huge 40 percent-50 percent surge in live cattle prices, the boxed beef values have gone up in lock-step. We saw early week values for the Choice types above $200 before Tuesday morning brought weakness. The September price for Choice beef at retail was up a little more than 10 percent compared to last year's September price, from $3.29 to $3.71. That price shows little of the sharp run-up at the live cattle and boxed beef levels that is due, in my opinion, to the abrupt reduction in supply when the Canadian border was closed and we reduced the available supply of slaughter cattle by about 9 percent. If you reduce the supply of cattle abruptly about 9 percent with a demand elasticity of around -.5 at the live animal level, we would expect prices to go up about 18 percent if demand is constant. If you take an $80 cattle market and increase price by about 18 percent because of an abrupt reduction in supplies, we are looking at the mid-$90s. As I have been saying in recent weeks, these price increases will come to a short-term top when we start seeing a substantial part of the increased prices at the cattle and boxed beef levels moved up to the consumer and the consumer will back off and take a lower quantity of beef at the higher prices. It is interesting to reflect on the fact that the near-term futures are $97-$98 and the June 2004, arguably because analysts expect the Canadian situation to be settled before then, is trading around $75.
There is talk about the futures still being below cash and that the futures therefore have to trade up. But I suspect the discount we are seeing in futures is coming from the pervasive uncertainty about when the Canadian situation will get resolved. This is a time when I think keeping some fail-save protection in place with an out-of-the-money put or something of this sort on contracts out through February will make sense. When the Canadian border opens again, we could see price declines that approach being as dramatic as the ones we have seen on the upside. I would seek protection against that type of possibility in both the live cattle and the feeder cattle futures.
The hog market is feeling some of the volatility and the uncertainty that is coming over from the beef complex, and it is feeling the weight of seasonal increases in daily slaughter levels that are running bigger than most had anticipated. Early last week, the December lean hog contract ran above the $60 level and tried to take out the old contract high, which had been $59.50 back on September 11. Then the heavier slaughter levels and some weakness in pork cutout started to hit the market and there was a major price plunge to the downside on Monday and December closed limit down on Tuesday. I would hold short hedges in this market into the early months of next year. It has not been an easy thing to do, but I have been suggesting in recent weeks that this market needs to be rewarded with short hedges and selling when it rallies to the highs. It appears that we have a fairly normal seasonal increase in daily slaughter levels in spite of the fact that the reports had been showing the breeding herd and total inventories in a bit more positive vane.
By comparison, the normally volatile grain and oilseed markets look tame as we monitor recent action. Corn continues to feel some pressure coming from that record crop in the October report above 10.2 billion bushels. Soybeans continue to find support because of the substantial reduction in the crop estimate in the October report. We had some export activity on Monday with China buying 275,000 metric tons of soybeans. These markets are trying to find a level that will be low enough to clear the corn market without building stocks in a huge way and trying to find a price that will be high enough to ration usage in soybeans, soybean oil, and soybean meal. Wheat is responding to what is going on in the world market and responding to weather.
The soybean market has had two weeks to register the impact of the bullish October 10 report. With the November soybean futures up in the $7.30-$7.40 level and trading in the low $7.30s on Tuesday, I suspect this is about all we are going to see to the upside, and that raises my interest in looking toward the 2004 crop. The November 2004 futures gapped to the upside on October 17, something of a delayed reaction to the report. Remember, the November 2004 has to try to register the impact of crop developments in the U.S. in 2003 and 2004 and also anticipate what these higher prices will do in terms of enlarged crops in South America where we are now moving into the planting season. Contract high on the 2004 November soybean contract is just above $5.86. On rallies, I would look at selling old-crop soybeans, especially if you don't have them hedged in a storage program at a profit, and think about starting a pricing program on the 2004 crop. Don't make the November 2004 go to its high at $5.86. I would say anything in the $5.80-$5.81 range would merit a look at forward pricing about 25 percent of the expected crop for next year.
Corn is on the other end of the continuum in terms of current price action having dipped down toward the contract lows around $2.09 on Monday and recorded a low of $2.13 1/4. This market is trying to show a modest rally in Tuesday's action. I would be buying back short hedges on the 2003 crop at these levels since there is limited risk to the downside. As a user of corn, I would get long hedges established again and I would look to be long again on long hedges and space those positions out through 2004 to meet your seasonal needs in corn.
The December Chicago 2003 wheat moved down significantly from the August 18 high that reached $3.99 and traded as low as $3.38 on September 19. This market then corrected a significant part of that price break, rallying to prices as high as $3.67 on October 2 and then broke hard during the first week of October. It is trying to build some short-term bottoming action in the $3.25-$3.35 level on the December contract. The correction to the upside after the break from the August 18 high carried the July 2004 as high as $3.45 on September 30, a penny below the contract high from August 18 at $3.46. That was an excellent short hedging opportunity and I would hold those short hedge positions. I wanted to get up to 40 percent forward priced in the hard red winter wheat market on any rally back up to $3.50 or better on the July 2004 in Kansas City, and I have said in recent weeks that I would now lower my sights and move up to 40 percent forward priced if you can get a rally to the $3.42-$3.43 area. We have a significant number of highs where the market quit during September around the $3.42-$3.45 level on the July 2004 Kansas City contract.
