Cattle Markets Have Many Moving Parts
by Troy Applehans, Market Analyst, CattleFax
What a tremendous variance in emotion, perspective and market psychology on behalf of cattle producers and especially cow-calf operators over the past two years from the two years preceding. Cow-calf producers have endured the bulk of the decline in margin, at the same time they had the most margin to lose. Think of it this way, there’s only so much margin per animal and each segment (i.e. cow-calf, stocker, feedyard, packer, retailer) is attempting to get the highest percentage of the pie. As the accompanying chart indicates, cow-calf producers have been the biggest benefactor with regard to margin per animal to the detriment of other segments, namely feedyard and stocker operators. At some point there is a “redistribution of margin” due to the non-profitable segments simply having to pay less and buy margin in order to remain in business. Leverage transfers to another segment. This is what the cow-calf sector has endured the past couple of years, and potentially will continue to undergo for several more.
The bull market of 2013 and 2014 were years that producers never experienced with regard to profitability and upward price trajectory. Now, after back to back bear market years of 2015 and so far in 2016, just the opposite is true. The market swiftly moved into uncharted territory to the high side, followed by the most rapid percentage price decline in history, all in a relatively short period of time. The quick trip down got the market to levels most would not have anticipated would occur until 2018 or early 2019.
What entirely is responsible for the market downfall is not easily quantified, because it’s not one, two or even ten easily identifiable items that can be pinpointed. There are an incredible number of moving parts that impact commodity markets in general. Supply and demand are primary components of commodity prices, but so are a multitude of other items such as imports, exports, competition, global and domestic economies, politics, weather, currencies, investment funds, etc. just to name a few. But, the underlying reality of the situation is that fall delivered calf values in 2016, for the most part, are running over $100/cwt below where they were in 2015, and close to $150/cwt lower than the peak in late 2014.
Commodity prices at some point move towards the “average” cost of production. Recent examples of this are the grain and crude oil markets. Often times what happens is high cost and/or low return producers are the first to lose money, next the most inefficient of average producers begin to lose money. In the case of cow-calf producers, history has shown that many of them are willing to endure losses on two consecutive calf crops before beginning to liquidate cow inventories due to lack of profit. This is how cattle and commodity cycles work. Expansion occurs due to profitability, which is most often the result of low inventories. Enough expansion results in lower prices, due to larger supplies. At some point when prices decline to the point average producers are losing equity, liquidation begins to occur. Yet in the case of cattle, prices are slow to respond due to the additional tonnage of product as a result of increased cow slaughter. This is supply fundamentals in its simplest form. What is clearly more difficult to measure and take into account is demand. And what is not possible to quantify are all the other moving parts and variables of markets mentioned earlier.
Presently a large component impacting cattle markets are the burdensome supplies of competing proteins. Total meat production is simply larger than domestic and current exportable consumption at the present time. Pork and poultry producers, at this point, have little incentive to curb production since most are at a breakeven to profitable regarding returns. Cattle numbers, after rapid expansion, will also continue to grow for the next several years. Cattle packing plant utilization rates are extremely high, giving the packing segment of production tremendous leverage over segments below them. Retailers remain profitable on beef due to continued high beef prices for consumers, as well as plenty of options regarding abundant supplies of lower priced alternative proteins.
So, how do cattle producers regain leverage and begin to see higher values? Simply put, it’s going to take time. The pure vastness of the challenges for cattle producers don’t heal overnight. Now obviously, if China were to open and accept imports of U.S. beef, something of that nature is an immediate game-changer. Significantly increasing not only beef, but total meat exports can be a tremendous help, but the global economy has to be able to support the increase and currency values be more advantageous to exporting countries. Packer and retailer margins can decrease, yet they can remain profitable in order to move more product to the consumer. At some point the competing proteins can lose the incentive to produce more and limit protein production – pork and poultry producers have the ability to significantly increase or decrease production rapidly. There are a multitude of ways the cattle market can increase, but looking for something to wave the magic wand is risky to bet on. And hoping the market will go higher is simply not a good strategy.
The odds are that this cattle cycle will have to play itself out just like the previous cycles before it. The accompanying chart illustrates that earlier cycles historically lasted 10-12 years, either from a high to a high or a low to a low. If history repeats itself, the 2014 high in cattle prices would indicate a possible low 5 to 6 years down the road. That’s a long time and certainly doesn’t mean you can’t be profitable during down cycle years, just less profitable. Is this a quicker cycle? Possibly, especially considering how quickly the market decline has been. Is the bulk of the decline behind us? That would make sense, but doesn’t mean there still isn’t risk for lower prices going forward. Managing risk and equity preservation become that much more important for cattlemen going forward. Manage your risk…Don’t be great at what you do and have the market take you out!