Setting the tone

by Steve Kay
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Cattle resting in a field
Meat and poultry exports are thus expected to increase in volume this year, but values will decline sharply from 2015.

Demand at home and abroad is always a key to whether US meat and poultry companies make money or not. It will be even more important in 2016 as domestic red meat and poultry production is expected to increase 2.7 percent from 2015. While that might not seem like a large increase, it will occur even as Americans remain restrained in their beef purchasing and export values are set to decline sharply.

Beef production is likely to increase 4.3 percent from 2015 to 24.680 billion lbs., says the US Dept. of Agriculture. Pork production will remain ahead of beef at 24.925 billion lbs., (up 1.6 percent) and broiler production will increase 1.8 percent to 40.900 billion lbs. Meat and poultry production will total 97.284 billion lbs.

Meat and poultry exports are thus expected to increase 5 percent in volume this year. But values will decline sharply from 2015 because of the increased production, the strong US dollar and the economic slowdown in key Asian markets. The value of beef and pork exports alone will likely decline by 11.5 percent, USDA says.

Just before the Christmas holiday, the industry breathed a sigh of relief as mandatory country of origin labeling for beef and pork at retail was repealed through the $1.15 trillion omnibus spending bill. It meant Canada and Mexico decided not to impose just over $1 billion in annual retaliatory tariffs on US goods, including beef and pork. This averted a significant disruption to US meat and livestock markets. On Dec. 18, the futures markets responded positively by putting all live cattle and feeder cattle contracts up to the limit.

While the percentage of production of beef, pork and chicken that is exported varies considerably with each species, the domestic market remains critical for each. That’s why weak consumer spending on beef in 2015 impacted this sector so much and caused wholesale beef prices and fed cattle prices to collapse at times.

One of the most disturbing patterns of the year was how boxed beef prices ran up prior to each of the big three holiday weeks of the year and then retreated. Beef could not sustain a rally because retail prices were at near-record levels despite holiday featuring, and because beef was priced far above pork and chicken.

Beef suffered from this lack of competiveness all year, and 2016 will see more of the same. Monthly retail beef prices in October were only 1.7 percent higher than the year before, but pork prices were 4.3 percent lower and chicken was 1 percent lower. More important, the combined pork and chicken price was lower than the all beef price.

Competitive spending

Last year’s weakness in consumer spending on beef came despite massive consumer savings from lower energy costs. But consumers were unwilling to increase their spending on beef and instead elected to save and spend on durable goods such as autos, homes and home furnishings, says analyst Andrew Gottschalk of HedgersEdge.com. The competition for the consumer dollar was more than competition within the meat complex. The competition was between food, savings and durable goods, he says.

The deeper issue is whether Americans have permanently adjusted their protein-buying habits at the expense of beef. Americans continue to eat a record amount of chicken but that’s more a function of availability than price. Some analysts suggest that consumers traded down in their beef purchasing during the Great Recession. Instead of buying steaks regularly, they bought more ground beef and less expensive cuts. That trading down has never gone away, and now consumers are trading down from beef items to pork and chicken.

That’s not surprising given the price differentials. Ground beef in its many forms is the beef industry’s most widely consumed product. But when the average price of retail ground beef exceeded $4 per lb. in August 2014, it became less price-competitive. That price hit a record $4.24 in February last year and only gradually declined after that. It was still at $4.08 last October, compared to $3.97 for all fresh pork items and $1.97 for chicken. Ground beef sales thus weakened as 2015 went on. This caused the price of 90CL (lean manufacturing beef) to hit its lowest level in the second week of December since mid-February 2014.

Another consumer behavior seen last year was that shoppers “cherry picked” the featured beef items and did not buy items offered at everyday prices. This was a Catch-22 for retailers. As much as they wanted to feature beef more aggressively, they were loath to do so unless the features generated enough sales volume to more than make up for the loss of volume of items at everyday prices. In turn, they were loath to lower their everyday prices much because of the volatility in the wholesale beef market.

Craving stability

The beef sector will be craving more market stability after ending one of the most volatile years ever. The futures market’s volatility caused headaches up and down the beef production chain. Cow-calf and stocker operators, cattle feeders and packers all use live cattle futures to lay off risk and attempt to set prices. Setting prices became more and more difficult in 2015 for packers selling beef forward. If a packer wants to hedge a forward position on beef, he bundles together the items he is selling and then looks at the live cattle contracts. For example, if he is selling a load of chuck rolls, he will hedge two loads of cattle. If he is selling a load of tenderloins, he will hedge three loads of cattle. But the futures’ volatility last year made it more difficult to know what level to hedge at.

The volatility also impacted spreading or crushes as a risk management tool. Spreading involves two different contracts, e.g., the live cattle/live hog contracts, or the February and August live cattle contracts. A crush is when someone bundles together the components that make up the end product. For beef, it means using feeder cattle and corn futures as inputs and live cattle contracts as the output. Those using a crush would go long on the inputs and short on the output. A pork crush would use the live hog, corn and soybean contracts.

The volatility shattered producers’ and packers’ ability to lay off risk and likely cost the industry hundreds of millions of dollars. For example, Tyson Foods’ beef segment incurred $70 million of hedging losses in September when the October live cattle contract lost $20 per cwt. Tyson had hedged its forward beef sales against that contract.

The futures’ collapse then and again in November also caused cash live cattle prices to collapse as well. This guaranteed that cattle feeders would have their worst year ever of losses. That was after having their second-best ever year of profits in 2014. September’s market collapse meant a new low in cash live cattle the first week of October. The average price that week was 30 percent lower than the weekly high the first week of January. Prices rallied in October but then collapsed again. Average prices the second week of December nearly put in another new low for the year, and cattle feeding losses remained in the $250 to $500 per head range.

Some people cited the demise of the pits and open outcry trading as a factor in the volatility. Computerized, high-frequency trading now dominates and some say such trading is divorced from the market fundamentals. But this will continue to occur this year so volatility will remain in the market.

At the same time, the live cattle cash market continued to shrink in 2015, with only 20 percent of all cattle sold in this way. This and the futures’ unreliability as a risk management tool are interlinked as price discovery in the live cattle market is facing a threat not seen in many years. The industry will need to address this issue in a way it has not done to date.

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