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Cattle margins struggling amidst lower prices

Market Update with Jerry Klassen

Western Canadian fed and feeder cattle prices have experienced severe volatility over the past month and it appears that this price behaviour will continue over the winter.

While the market continues to factor in growing beef supplies, retail and restaurant demand remains uncertain. Alberta packers have been buying fed cattle in the range of $170 to $172 in mid November and current purchases will only be picked up in early December.

Feedlot margins continue to hover in red ink with break-even pen closeouts in the range of $195 to $200. Despite the negative margin structure, feeder cattle prices have actually held up fairly well with 800-pound steers trading in the range of $245 to $248 in central Alberta. It usually takes one full round of negative margins before feeder cattle drop to levels where feedlots can make a profit.

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Most feedlots were carrying minimal numbers through the summer and early fall so we’ll only see the extent of the negative margins on the feeder market in early spring. There are many factors to consider moving forward and cattle producers should be aware of the expected price environment over the next four to six months.

U.S. production increasing

In the first half of 2016 the USDA is projecting a year-over-year increase of 215 million pounds during the first quarter and a whopping 605 million pound increase in the second quarter. Production from the April through June of 2016 will be very similar to 2012 and 2013 and during that time, the live cattle futures traded in the range of US$120 to US$130. As of mid-November, the April 2016 live cattle futures were near US$133 while the June contract was closer to US$125. Therefore, we can say that the downside risk in the June live cattle futures is limited from current levels whereas the April contract is probably fairly priced. Breakeven pen closeouts on replacement cattle are near $200 for April and with the current cash price near $170 in Alberta, it is difficult to justify a $30 rally even if we see further weakness in the Canadian dollar.

US-quarterly-beef-production

Source: USDA

Overall demand will likely remain stagnant moving forward with potential seasonal rallies. The U.S. unemployment rate in October was five per cent, which is close to pre-recession levels of 2009. We may see some marginal changes on either side of this level over the next month but nothing significant to realize a shift in the demand equation.

Secondly, disposable income levels is expected to remain rather constant now that U.S. consumers have adjusted their home budgets to lower energy prices and the stronger greenback. Therefore, we may see a minor increase in beef consumption levels in December in line with the seasonal tendency but then consumers tend to cut back sharply in January and February. Once packers cover their needs through December, the fed cattle market will become vulnerable to softer demand and growing supplies in January in March.

Feeder market gloomy

I’ve received many calls during the past month from backgrounding operators wondering about the price outlook for calves and yearlings next spring. The feeder market has held up remarkably well despite the inability to lock in a profit on calves and yearlings. The market may hold value for the time being until feedlots have sufficient ownership but the outlook for January through April is somewhat gloomy.

During declining markets, the futures tend to lead the cash market lower making it very difficult for producers to hedge or lock in a margin. If a grain trader bought wheat that he could not sell at a profit, he would be led out the door immediately. This grain trader would be considered insane. However, with cattle operations it’s a bit different because I’m seeing backgrounders load up on cattle like there is no tomorrow.

The only words of advice for producers are not to load up and carry minimal numbers until the market levels out and it will level out at some point. I’ve heard excuses like tax reasons or weather is optimal or cattle quality deteriorates in December but none of these excuses justify buying cattle when you can’t at least see a profitable period looking forward.

Cash for a feedlot operator is like a hammer to a carpenter. Remember, markets tend to over-extend themselves on the way up and on the way down. Backgrounding operators need to buy lightweight calves next March or April so these cattle will hit the fed market in November or December of 2016. This is probably the opportunity given market behaviour from past cycles and current beef production estimates.

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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