Over the past month, I’ve received many inquiries from cattle producers in regards to the relationship between crude oil prices and the cattle market in Western Canada. Cattle prices have remained near historical highs while crude oil values have dropped by nearly 60 per cent since the summer of 2014.
Often we are confident that we notice everything that happens in front of us but fail to see outside this realm. This is because we are focused on certain factors, such as beef supply and we don’t notice other factors. This is often referred to as a “Black Swan” variable or “illusion of attention.”
During the recession of 2009, all commodities and equity markets drifted lower as the economy contracted. However in our current environment, certain world economies are struggling, but the U.S. has managed to continue on a moderate expansionary phase and has somewhat been enhanced by the lower energy prices. The extra income obtained for the average consumer due to lower energy values has kept consumer spending relatively strong, which is the largest component influencing beef demand.
If you ask three different analysts about the effects of lower crude oil on the cattle market, you will probably receive three different answers and that is because it is very difficult to forecast. As I studied this issue further I had mixed views as well. Sometimes, it is a good idea to take a step back and look at the whole economic picture in order to have a better idea of future price behaviour.
All about consumer spending
First, it is important to remember that consumer income and spending is the largest factor influencing beef demand. When consumers have more money to spend on food at home or away from home, beef and cattle prices tend to move higher.
I’ve mentioned in previous articles that as U.S. GDP rises, cattle prices also rise because nearly 70 per cent of U.S. GDP is consumer spending. This is especially important for beef because nearly 50 per cent of the carcass is consumed by people with average to above-average income. During the latest recession, consumer income deteriorated and cattle prices fell. However, once the recovery started, beef and cattle prices started to trend higher and there has never been a significant pullback in the cattle market since the lows of 2009.
If consumer spending is the largest variable influencing beef demand, then it is important to also look at equity values. In this simple study, I looked at the Dow Jones Industrial average since it is a very broad view of the overall economy and consumer spending. I simply took the monthly closing prices of the Dow, NYMEX crude oil and CME live cattle futures back to January 2008.
What affects spending?
I ran a correlation between the Dow Jones industrial average and live cattle futures prices. The correlation coefficient was 0.93, which is quite high and also to be expected. If the U.S. equity markets move higher, cattle prices will also generally follow. However, when I ran a correlation between live cattle futures prices and crude oil prices, the correlation was only 0.27 which is quite low. From that I can conclude that crude oil prices have very little influence on the cattle market. If the correlation coefficient is close to or at zero, then there is no relation between two sets of data.
I even tried to look for patterns by lagging the data. For example, does the cattle market follow the crude oil for to six to eight months later? The correlation coefficient was even lower. Therefore, I basically came to the conclusion that there was very little if any direct influence of crude oil on the cattle market.
For interest, I ran a correlation between the monthly closes on the Canadian dollar and crude oil prices. The correlation coefficient between monthly closes was 0.70 which is quite high and also to be expected. Given our dependence on the U.S. market for cattle and beef products, this is one positive aspect for cattle producers of weaker crude oil prices. As crude oil prices grind lower, our exchange rate with the U.S will also deteriorate due to lower demand for Canadian dollars.
In my view, the price of crude oil has very little, if any, effect on the cattle and beef markets. The minor influence of weaker crude oil on the overall economy will be largely offset and more with the benefit of the weaker Canadian dollar. Secondly, consumers will have more income to spend on food products due to lower energy prices.
Cattle producers can conclude any major factor that increases consumer income, will have a positive effect on cattle prices. We may see government spending contract due to lower income from oil companies, but the effect on the bulk of the population will be minimal.