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Market recovery still a year away

Market Update: Production is still high, start of beef herd contraction possible in late 2017

On top of the CBOT building in Chicago stands a statue of “Ceres” — the Greek goddess of grain crops and fertility. An old myth amongst traders is that after a major bull run in a market when traders usually did very well, the Greek goddess wanted her money back.

Fed cattle prices have been percolating higher over the last month. Alberta packers were buying fed cattle in the range of $138 to $140 in mid-November, which was up about $10 from a month earlier. The weaker Canadian dollar along with a marginal decrease in market-ready supplies resulted in the firmer price structure. Fed cattle values are nearing break-even pen closeout values, which has rejuvenated buying interest in the feeder complex.

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Feeder cattle markets have risen approximately $5 to $8 on average in comparison to a month earlier. Yearlings have moved through the system and the focus is now on calves. A small group of larger-frame Charolais-cross medium-flesh weaned steers weighing just under 700 pounds were quoted at $172 in southern Alberta. Favourable weather in early November caused the premium for weaned calves to erode over lighter unweaned bawlers. However, the market will have to ratchet higher in the deferred positions so that these cattle can be profitable.

Higher U.S. production

The USDA once again increased production expectations. It now appears that fourth-quarter production will reach 6.465 billion pounds, a year-over-year increase of 356 million pounds. The cow slaughter has picked up over the past eight weeks resulting in the larger-than-expected beef production. However, I want to once again draw attention to the first quarter of 2017 when production tapers off to 6.140 million pounds. At the time of writing this article, the February live cattle futures were trading at similar value to the December contract. I’m expecting a rally of $10 to $15 from now until early March in fed cattle prices. Notice the surge in production in the second and third quarters of 2017. Backgrounding and feedlot operators should be quite aggressive with their hedging strategies in March of 2017. During the spring and summer of 2017, the fed cattle market could drop to values similar to 2012 when Alberta fed cattle traded from $110 to $115.

Cattle on feed as of Nov. 1 in Alberta and Saskatchewan totalled 741,853 head, down 15 per cent from Nov. 1 of 2015. Placements during October came in at 299,972 head, down only one per cent from October of 2015. Cow-calf producers have delayed feeder cattle marketings this fall and I’m expecting a year-over-year increase in placement numbers during November and December. Alberta fed cattle basis levels have the potential to remain historically strong until March. During the spring and summer of 2017, Alberta basis levels will weaken because of the surge in U.S. fed cattle production. This will severely depress feeder cattle prices.

Source: USDA

Source: USDA

Little upside potential

Cow-calf producers have experienced sticker shock this fall, realizing that feeder cattle are trading nearly 35 per cent below year-ago levels. The sad news is that there is limited upside potential. I’m expecting feeder cattle prices to marginally strengthen over the winter but the market will come under severe pressure in spring and summer. Given the price of calves this fall, feedlot margins will hover in red ink once again from April through October resulting in lower replacement values.

I mentioned that the cow slaughter has increased and I’m expecting the U.S. herd to move into a contraction phase in the latter half of 2017. This is characterized by a year-over-year decrease in heifer retention and larger cow slaughter. Feed grain supplies will be burdensome during the 2016-17 crop year but strength in the feed grain complex could further enhance herd contraction in the fall of 2017.

Feedlots have experienced negative margins for approximately 15 months. There is always the tax-related buying late in the calendar year. During 2017, feedlots will be more disciplined in their feeder cattle purchases. Investment feeders looking for a non-correlated asset in their portfolios may also shy away, given the risk/reward analysis. The capital required for feeding cattle does not justify the risk. The absence of these players may also contribute to the lower price structure for feeder cattle.

It appears the Greek goddess “Ceres” isn’t quite satisfied and it may take another year to cure the curse in the cattle market.

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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