Fed and feeder cattle prices have been quite volatile over the past month. Lower supplies of market-ready cattle along with seasonally strong demand have contributed to the recent rally in the nearby live cattle futures.
This strength has spilled over into the deferred live cattle futures contracts and allowed feedlots to bid up the price of feeder cattle. Adverse weather across the U.S. Midwest has contributed to the recent volatility as the futures market incorporated a risk premium due to the uncertainty in beef production. Back on March 19, U.S. Agriculture Secretary Sonny Perdue told Fox Business Network the governors of Nebraska and Iowa told him that up to one million calves may have been killed. This news added to market uncertainty.
On any given day, one can look for reasons for the market to go up or down. The news can be overwhelming and lead to emotional decisions. Therefore, I always advise cattle producers to look at the “Commitment of Traders Report.” This report tells produces who is long and who is short and by how much. This is a vital piece of information when studying market conditions. Secondly, the cattle futures market exhibits a characteristic called the “constellation of prices.” Studying the commitment of traders report along with understanding the “constellation” market behaviour can be a valuable tool for deciding when to market cattle or when to take price insurance on your calves or yearlings.
I’ll specifically focus on the “Disaggregated Commitments of Traders Report.” There are four categories. The first category is the Producer/Merchant/Processor/User. This category uses the futures market to manage price risk, commonly known as the hedger or commercial. The Swap Dealer uses futures to manage risk for swap transactions. It’s important to be aware of this player, but don’t focus on swap dealers. The third player is the Money Manager, which is extremely important to watch. These players manage money and invest in futures markets on behalf of clients or funds. The Other Reportable category is for all other traders who are not in the previous three categories.
The grain bin example
Consider a commercial wheat trader with one 20,000-bushel grain bin for storage. This merchant buys from farmers using a traditional basis level but the merchant isn’t selling to end users for whatever reason. The grain merchant is completely hedged so every bushel that’s bought is sold on the futures market. The bin is filling up and the merchant lowers his basis for purchasing because no grain has been sold. Finally, the bin is full, the merchant lowers the basis dramatically and only accepts contracts for futures purchases two months forward. When the wheat merchant’s storage is full, the merchant is long 20,000 bushels in the cash market and short 20,000 bushels in the futures market. Regardless of the news, when the bin is full, the merchant cannot buy anymore and the market has to go down.
The managed money is usually the player on the opposite side of the commercial or hedger. I’ve included a chart showing the net long position on the live cattle futures. In November of 2017, the managed money had a record long of 138,758 which was the previous high on the chart. After this the market started to go down. On March 26 the managed money is now long 148,452 contracts. These funds also have a limit. When the funds are long their maximum, there is no major player left to buy at the higher levels. These traders usually trade along the major trend.
On the flip side, we have the commercial who was short 216,706 contracts on March 26. Over the past two years, this is the largest short position. This is similar to the grain merchant’s bin being full and the merchant is short the maximum 20,000 bushels. Around this time, the market usually tops out and is an opportunity for cattle producers to buy price insurance or place hedges. One will never pick the absolute top but this situation is a strong signal that it’s nearby.