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A good year to consider backgrounding cattle

Prices expected to be weakest during the fall of 2016

The U.S. cattle herd has been in the expansion phase over the past couple of years and it is difficult for many producers to come to terms with the recent price activity. I’ve received many calls from both cow-calf operators and feedlot operators in regards to the price outlook and I basically focus on the beef supply projections. This generally puts the market in a clear perspective.

Last fall and winter, feeder cattle prices held up fairly well as many feedlot operators were anticipating ongoing favourable margins as in the first half of 2015. However, this was rather short-lived as both feeder and fed cattle prices have trended lower and feeding margins have suffered in red ink for a prolonged period.

At the same time, history indicates the cattle herd generally expands for two years after historical highs. Cow-calf producers who bought high-priced cows or pairs last year are now contending with lower financial returns given the weaker feeder cattle prices.

I thought this would be an opportune time to discuss the beef supply situation since the USDA updated their forecasts for 2016 and provided a forecast for 2017 beef and pork production. This can help provide a marketing strategy for feeder cattle. Feedlots can use this to be more aggressive on purchases and have a better idea when to forward contract fed cattle.

us quarterly beef production

Numbers increasing

The 2015 U.S. calf crop was 34.3 million head, up 0.8 million head from 2014. Without going into details of projected cow slaughter and heifer retention, the 2016 calf crop is expected to experience a similar increase. Cow-calf producers tend to expand at the highs because they expect prices to remain stable or increase. However, this is not the case.

U.S. cattle-on-feed numbers have been running one to two per cent above year-ago levels, but we may see this increase to three to four per cent later in summer.

On the recent USDA WASDE report, second-quarter beef production was marginally revised downward, but increases were noted in the third and fourth quarter. Second-quarter beef production is expected to be up 230 million pounds over last year; however, third-quarter beef production is when supplies surge nearly 400 million pounds above year-ago levels. Production tapers off in the final quarter of 2016 and drops in the first quarter of 2017.

The third quarter will be the lowest price for fed cattle and feeder cattle. I mentioned in previous issues that this is also a period of seasonal low demand. Cow-calf producers should avoid marketing feeders during in the latter half of 2016. This fall is the year where it will be profitable to background and you’ll want to sell feeders as yearlings in January through March 2017.

For feedlot operators, this will be the opportunity to fill up in August and September of 2016. However, you will not want to forward-contract immediately because you will leave money on the table. Seasonal high prices are usually made in mid-March. This may be the one round of feeding that producers don’t forward contract fed cattle to take advantage of the tighter supplies in the first quarter.

When feedlots reload in February through April of 2017, this is the time to be heavily hedged up. The accompanying table shows the second through fourth quarter beef production has sharp year-over-year increases.

Watch for pricing opportunities

Futures markets exhibit a “constellation of price activity” whereby the deferred futures behave like the nearby contract. The front month is the price discovery and deferred contracts may hold a premium or discount but move in tandem. Once the front month goes into delivery, the next contract is price discovery. When the April 2017 contract peaks, likely in mid-March, the deferred contracts will also be at the highest levels. This is when producers need to forward contract or hedge up.

An old university prof told me 22 years ago, in declining cattle markets, the futures market leads the cash market lower. Therefore, it is almost impossible to hedge a profit because feeder cattle will be too high and the deferred contracts are a sharp discount due to the anticipated jump in supplies — exactly what we’ve seen this past year. A profound statement with more value than my entire education. I also want to point out that 2017 production is expected to be very similar to 2013. The economy is at full employment and wages are higher. We also have to consider the exchange rate; in any case, we have to be cognizant of the downside potential.

Analyzing quarterly beef production can be a very useful took in planning your marketing. Understanding how futures markets work in declining markets is also valuable when deciding when to forward contract fed and feeder cattle.

About the author

Columnist

Jerry Klassen

Jerry Klassen is manager of the Canadian office for Swiss-based grain trader GAP SA Grains and Products Ltd. and also president and founder of Resilient Capital, a specialist in commodity futures trading and commodity market analysis. He can be reached at (204) 504-8339 or visit his website at www.resilcapital.com.

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