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Looking at the feed grain component

Risk Management Part 5: More feeder cattle equals more feedlot placements, equals larger beef production

With this final article for the series on risk management for cow-calf producers, I note the previous columns discussed a specific aspect of the cash and futures market relationships. Producers are aware of when basis and futures levels are favourable and can use this information for buying price insurance or placing hedges on the feeder cattle futures. In Part 4 of this series, I provided an overview of the Commitment of Traders Report. Producers can use the information regarding the commercial and non-commercial net position to aid in market direction and timing on risk management strategies. In this issue, I want to take the market analysis one step further and incorporate the feed grain component.

Western Canadian barley prices have increased by nearly $50/mt over the past five months. Canadian barley stocks will be historically tight at the end of the 2017-18 crop year and there is potential for further upside. In the fall of 2017, the cost per pound of gain in Alberta for yearlings was about $0.96 (all costs). At the time of writing this article with barley around $248/mt in Lethbridge, the costs per pound gain were about $1.12. Keep in mind straw has also increased in value with quotes around $125/mt in Coaldale (east of Lethbridge). The cost per pound gain has increased about 17 per cent over the past five months. I’m not going to go into detail but the price of barley is highly correlated with corn.

The accompanying chart shows the May feeder cattle futures minus the October live cattle contract. Remember the feeder cattle futures reflects the live cattle market five months forward. During the fall period, if you’re buying calves to background over the winter, it is imperative you watch this spread. Notice this spread has gone from highs near $40 back in November down to $28 in late March. The narrowing of this spread is the result of rising price of corn.

There is a formula for finishing feedlots use to hedge their feeding margins. This formula includes selling six live cattle contracts minus the sum of three feeder contracts and two contracts of corn). It is important producers are somewhat knowledgeable how the price structure for feeder cattle changes when the feed grain prices strengthen.

General observations

There are a couple general observations one can make. Corn prices are usually the lowest during the harvest period. After harvest, the corn market tends to trade sideways. In 2017, the low corn prices around the harvest period attributed to the strong feeder cattle premium over the live cattle contract. During spring, the corn market is digesting acreage intentions and lower acreage can result in higher prices. This is the exact case for this spring. During summer, the corn market can be quite volatile due to weather and yield development. Notice July 2017 on the chart. This spread was also around $28 when corn futures were trading near yearly highs. These are a couple of seasonal tendencies that can be very useful when planning on your marketing strategy or hedging / price insurance strategy.

I want to close the 2018 risk management series with a lesson in simple economics. When hockey players go on the ice for warmup, they first practise the basics. Similarly, when producers call me and inquire about the markets, I often start off with the basics. The U.S. has experienced three consecutive year-over-year increases in the calf crop. More feeder cattle equals more feedlot placements, equals larger beef production. The cattle market has been encouraging production since the historical high prices of 2015. When prices strengthen, production will also increase. The USDA releases its quarterly beef production estimates on each monthly WASDE report. U.S. second-quarter beef production is projected to reach 7.2 billion pounds, up from 2017 output of 6.4 billion pounds. When you have a 13 per cent increase in beef production, fed cattle prices are not going up. The market is now functioning to encourage demand. (How much are you going to pay for the third hamburger?). During the first quarter of 2018, cow-calf producers were facing a market contending with a sharp year-over-year increase in beef production and rising feed grain prices. Both factors will weigh on the feeder cattle market for the summer and fall period.

Cow-calf producers need to watch the feeder cattle premium over live cattle. Changes in corn and barley prices will influence the feeder market. Producers should also watch projections for quarterly beef production because this will influence the price direction for live cattle.

About the author

Columnist

Jerry Klassen manages the Canadian office of Swiss-based grain trader GAP  SA Grains and Produits Ltd., and is president and founder of Resilient Capital specializing in proprietary commodity futures trading and market analysis. Jerry consults with feedlots on risk management and writes a weekly cattle market commentary. He can be reached at 204 504 8339.

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