Beef behaving badly
Sept. 13, 2016
Analysts agree, the beef futures should not be ignored.
The US beef industry is being roiled by the worst market chaos since the US reported its first BSE case on Dec. 23, 2003. The chaos has nothing to do with an animal disease or food safety breakdown. The culprit is a futures market that has behaved irrationally for the past 18 months. Market participants and analysts agree the futures are not functioning as they should as a risk management or price discovery tool. Yet all are at a loss as to what to do.
The feeling that the futures were out of step with supply and demand fundamentals began early last year. The live cattle contract traded well below the cash market, which forced futures prices to rally just before a contract expired. Then came a futures sell-off last fall that caused a dramatic collapse in cash prices.
The futures market is an anticipatory market. So one might say its sell-off last fall was justified because of concerns about slow feedlot marketings, which resulted in steer and heifer carcass weights reaching record highs in October and November. But most market participants felt the futures had greatly exaggerated the impact of these factors. Almost as alarming was the futures’ volatility throughout the year, advancing sharply one day only to sell off the next.
Such aberrant behavior played havoc with cattle feeders’ ability to hedge cattle they were placing on feed, and on packers’ ability to sell forward beef at prices they could hedge against the futures.
The first three months of this year brought some respite from the volatility although the live cattle contract remained deeply negative to cash prices.
However, irrationality returned in June. In just two weeks, the June live cattle contract lost 795 points in six trading days. This caused cash live cattle prices (basis US Dept. of Agriculture’s 5-area average steer price) to decline $10.78 per cwt and for cattle feeders to lose an estimated $145 million. This loss suggests the futures’ behavior has caused producers to lose as much as $500 million in the past 18 months. This amount might be even larger considering gross income from cattle and calves in 2015 totaled $78.8 billion.
There have been no fundamental factors in the market to cause such eratic behavior, especially in June. In fact, the fundamentals then were the strongest in two years and suggested the futures should rally. Supply fundamentals were much more positive than in May-June 2015. Cattle feeders were selling cattle far more aggressively than last year. Packers put together their largest kills in June (over 600,000 head per week for three weeks in a row) in two years. Steer and overall carcass weights were running below year-ago levels for the first time in nearly two years. Feedlots were more current in their marketings than in three years. The front-end supply of cattle was 5 percent below year-ago levels on July 1 and will remain below a year ago in August and September.
Meanwhile, beef sales at retail and foodservice were much better than last year. Sales during the Memorial Day holiday week were robust and were even better in June. That’s because wholesale beef prices have been significantly lower than last year, allowing retailers to feature beef more aggressively. Beef sales for the July 4 holiday week were also much better than last year. July beef sales slowed because of the hot weather, but analysts expect to see strong retail beef features throughout August up to the Labor Day holiday.
Why the futures market is ignoring these fundamentals remains a mystery. The urgent question though is: What, if anything, can be done to address the futures market’s dysfunctional and volatile behavior? The answers to the following questions asked of some of the leading economic analysts are telling: Do you think the live and feeder cattle futures are broken and should be ignored? What do you think should occur to “repair” the futures? What would be the benefits of having no futures markets? What would be the disadvantages of having no futures markets?
All agreed that the futures are not functioning effectively. Jim Robb of the Livestock Marketing Information Center noted that for true hedgers, straightforward use of the futures for risk management and price discovery has been problematic since December 2014. Feeder cattle futures have also displayed some of these same concerns. Interestingly and importantly, the same issues have not been apparent in hog futures, feedstuffs (i.e. corn, soybeans, soybean meal), or wheat, he says.
All of the analysts agreed the futures should not be ignored. The futures provide useful and important market functions, Robb says. But as Oklahoma State Univ.’s Derrell Peel noted, recommending that the futures be ignored is a matter of hastening the inevitable collapse and limiting the interim damage that dysfunctional futures markets have on the cash market and the industry. The industry may be at or near that point, especially for feeder cattle futures, he says.
As for remedies, this is the most difficult question because there are no easy or obvious solutions, Peel says. The fundamental problem is not a new one. Live and especially feeder cattle futures have struggled for many years, with barely adequate levels of liquidity to function effectively. The problem has gotten worse recently due to a variety of factors, including expanded trading hours and daily trading limits, high speed computer trading and changing demographics of the speculator base of the market in which a larger proportion of trading is motivated by portfolio management rather than trading market fundamentals, Peel says.
How though does the industry address these factors without further reducing the liquidity of the live and feeder cattle contracts? The CME Group, which manages the contracts, will resist efforts to reduce trading levels because this would mean reduced fees it receives, and it is a for-profit entity, note observers. The beef industry will likely spend the rest of 2016 dealing with a dysfunctional futures market and losing more money because of it.