I’ve received numerous calls over the past month from cow-calf producers and backgrounding operators in regards to a marketing strategy for their individual operation. In four previous articles I’ve discussed the feeder cattle futures market and the historical relationship between the cash and futures market.
I analyzed basis levels and discussed using the basis and futures for calculating an expected forward price. I then focused on hedging with futures and options and commented a bit on market behaviour, such as the constellation of prices. When discussing the markets with producers, I always review what the futures market is telling us based on the current price structure. To finish the series, I thought it would be prudent to look at a couple of case studies. Reading the futures market in relation to the cash price can provide producers with a wealth of knowledge to make the best decision.
First, the feeder cattle futures market closes as of March 31 were as follows:
- May 2017 – 132.70
- Aug 2017 – 133.75
- Nov 2017 – 129.97
- Jan 2018 – 125.37
At the time of writing, steers weighing 850 pounds were averaging C$166 in Western Canada. Producer Bill, from Northern Manitoba Cattle Co., called and asked if he should finish a pen of steers averaging about that weight or if he should sell the cattle in the auction ring.
If we calculate the basis using the formula “May Futures minus the local cash price,” we come up with US$132.70 divided by the exchange of 0.7533 or C$176. Subtracting the cash price of $166 results in a $10 basis.
If you remember from my previous articles, the average basis in Manitoba for 850-pound steers is $20 with a standard deviation of $10. This means the cash price is relatively strong when the basis is this firm — the market is telling producers to sell now. Secondly, if Bill wants to put on another 50 or 100 pounds, the futures market is not rewarding producers for holding cattle because the deferred futures prices are relatively the same or slightly lower. Looking at history, the basis is likely to deteriorate so he won’t be rewarded for putting on the additional pounds.
The second caller was Betty from Saskatchewan Green Red Light Cattle Co. She stated that she owned 700-pound steers and was wondering if she should sell now or place them on grass over the spring and into summer. These larger-frame Simmental steers have been quoted as high as $194 in her local auction ring. Using the same calculation as above (futures minus cash in Canadian dollars) the basis is -$17.
First, this is an extremely strong basis level for her region. Secondly, if she plans to put on another 150 pounds, her expected forward price is calculated as follows:
August futures of US$133.75 divided by the exchange rate of 0.7533 equals C$177.55; then subtract an average basis of $20 = $157.55. If her cost per pound gain is 85 cents, she will not be rewarded for putting on the additional pounds. Betty should sell the cattle now and then look at buying some lighter-weight cattle later on for her pasture. The key is she may have to buy lighter 600-pound calves around the $200 area in order to make this more reasonable, or even look at heifers. If you have a decent profit now, it’s better to clear the table and start fresh under the current market conditions. Don’t use the fact that you have feed available to determine your marketing strategy.
Will it get better?
Both of these producers stated that “maybe the futures market will come up.” To that comment, I pointed out that the April live cattle futures were at US$119.95 and the August contract was at US$106.75. The deferred live cattle futures were trading at a US$13 discount to the nearby contract. The strong nearby cash fed-cattle price, which was also at a premium to the futures, had pulled up the feeder cattle prices = which resulted in a strong basis levels for their feeders. It’s hard to justify holding feeder cattle under the current price structure looking at the cash and futures markets.
I also want to point out that when the basis levels are so strong as we’ve seen over the past two months, it is quite costly to buy put options or to use the Livestock Price Insurance program. A rule of thumb is that buying put options is only favourable when the basis is weak and the deferred feeder cattle futures are at a premium to the nearby month. This is the combination needed to use put options or the Livestock Price Insurance program.
Many producers ask why the premiums are so costly. The reason is the strong basis and weaker deferred futures. Remember, the 2016 U.S. calf crop was one million head above 2015 so there are a lot more U.S. calves to come on the market this fall. In Canada, the 2016 calf crop was only 50,000 head above 2015. The Canadian basis will be stronger than the U.S. basis given the current fundamentals.
Producers should look at the cash and futures market and listen to what the market is telling them. You don’t have to “out guess” the market to be successful in the long run.