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Monday, June 30, 2014

Futures rally despite being overbought

by Kerry Halladay, Associate Editor

The cash fed market was slow to develop last week, and midweek futures movements likely had packers kicking themselves that they didn’t move faster.

“Let the fireworks begin!” announced Andrew Gottschalk of Hedgers Edge on Thursday morning. “The horse race is on to determine this week’s sales price for cattle.”

Asking prices started the week slightly elevated from the prior week’s sales of $148-150 live and $234-238 dressed. However, after a strong rally—again—in the futures markets, asking prices jumped up a few more dollars. By Thursday morning, cattle feeders were asking $153-154 live and $240-242 dressed.

“It is quite apparent that packers are going to have to pay up for cattle this week given the strength in the futures market, just how much more is yet to be seen,” noted Troy Vetterkind of Vetterkind Cattle Brokerage. He opined that the majority of the cash trade would likely be put off until Friday, despite the fact packers were buying for the reduced production week ahead of the 4th of July holiday weekend.

Last week was estimated to be a 610,000-618,000 head production week with this week challenged to reach 510,000 on account of the holiday. This decreased production estimate as well as continued hopeful domestic demand helped rally the futures, which in turn propped up asking prices. By Thursday afternoon, not even 4,000 head of cattle had been confirmed sold at $150 live and $236 dressed, but volumes were too low to establish the week’s trend.

Now… about that futures rally:

“Futures for feeders and fed cattle continue their march to higher levels despite being in an overbought condition,” Gottschalk pointed out Thursday, following the extensive rally seen Tuesday and continued with some restraint on Wednesday. Over the course of the week, the June contract for fed cattle gained $6.20 to settle Thursday at $153.75 while the August contract gained $6.42 at $152.75. Both Tuesday and Thursday saw triple-digit single-day gains and most of the contracts on the board were nearing $1 up on Wednesday. Over the course of the week, the June contract for fed cattle gained $6.20 to settle Thursday at $153.75 while the August contract gained $6.42 at $152.75. Both Tuesday and Thursday saw triple-digit single-day gains and most of the contracts on the board were nearing $1 up on Wednesday’s settle.

“Fed cattle futures have built significant premiums on the summer contracts after market participants severely underestimated the strength in the fed cattle market earlier in the spring,” commented Steve Meyer and Len Steiner of the CME Daily Livestock Report.

As always, analysts were speculating on the longevity of this already long overbought market’s continued rise, but for the near-term things appear to be optimistic. Domestic demand has weathered the continuing price storms impressively and export demand has remained a good source of value in the beef complex. But there is a test coming: What will demand look like after the fireworks fall dark?

“The main focus of market participants in the very short-term is how business develops going into the important 4th of July holiday weekend and also what kind of follow-through business retailers will enjoy after the holiday,” advised Meyer and Steiner.
Early in the week, Gottschalk commented on the impressive strength of domestic consumer demand in June.
“Second quarter retail beef demand increased approximately 4.8 percent. More importantly, quarter-to-quarter demand also improved. The latter did not occur without strong income gains by consumers. That said, the burden of proof is on the demand side as we approach the dog-days of summer.”

On this latter point he had a warning: “The summer target price for the beef cutout is being raised to $220 from $210 following the recent sharp advance.”

Whatever the cutout prices might be in the future, last week they were still very strong.

“Cash beef markets were higher again [Wednesday] with the market continuing its contra-seasonal rally and cutouts trading into new all-time historic highs,” reported Vetterkind. “Many are surprised by the strength of the beef market for this time of year, but packers continue to be well sold on beef inventory as exports remain strong, which leaves domestic buyers no alternative but to match packer offering prices.”

Over the course of the week, the Choice cutout gained $4.12 to close Thursday at $245.01. Select similarly gained $4.19 to close at $237.56. These gains don’t come without a cost, however. Gottschalk supplied more words of warning on this topic.

“Cutout values have attained a level which has eliminated retail beef margins given current retail beef prices. Beef features will be limited and/or retailers will advance prices to restore their margins post July 4th. This is not the best news ahead of the dog-days of summer. That said, any price correction should prove to be short-lived.”

Feeder cattle
Feeders continued ever upward last week with seemingly no end to the breakneck upward race in sight. Prices for medium and large 1-class (#1) steers in the 700-800 lbs. range were almost exclusively over $200.

California: In the Golden State, prices were called record high on stockers and feeders. There was big demand with prices up $2 on feeders (on top of last week’s gains). The Shasta Livestock Market sold 7-weight steers from $187-217.

Iowa: Prices in Iowa’s weekly roundup of regional auctions showed some noticeable increases in benchmark feeder prices. Seven-weight, #1 steers sold between $205.50 all the way up to $255.00 for a small package of thin-fleshed yearlings. Most collections were in the mid-$210 area.

Kansas: There was a light test over at the Pratt Livestock Feeder Cattle Auction. Steers over 700 lbs. were steady to up $3, with instances of $7. Heifers were steady to up $8. Benchmark steers went for $211.60-215. At the Winter Livestock Feeder Cattle Auction, there were too few feeders for a true trend, but there were instances of up $5-10. Close to 150 head of #1, 7-weight steers sold for between $205.50-210.50.

Missouri: The Joplin Regional Stockyards sold feeders of both sexes mostly steady on good demand. Benchmark steers sold between $204-221.

Nebraska: There was no trend available at the Bassett Livestock Auction but demand was called very good for all offerings. Seven-weight, #1 steers sold between $220-247 with the upper end coming for a collection of fancy steers.

Oklahoma: At the El Reno Livestock Market, feeder steers were up $7-10 with the exception of heavier benchmark steers, which fetched as much as $12-15 higher. Heifers brought $6-8 higher. Calves were too few for a market test. Prices on #1, 7-weight steers sold between $210-222.50. At the Oklahoma National Stockyards, feeder steers were steady to up $2 with instances of up $6. Heifers followed suit with steady to up $2 prices with instances of $5-7 higher. Calves were mostly down $4-5. Benchmark steers sold between $200-218.

The futures markets for feeders, like that of fed cattle, rallied powerfully last week. However, Gottschalk opined that feeder futures’ failure to correct its overbought status was a positive technical sign. Over the course of last week, the August feeder contract gained $8.25 to settle Thursday at $215.13. The September contract settled at $216.90, a gain of $8.72. Thursday alone saw limit up or near limit up gains across the entire board. Almost every day last week saw triple-digit daily gains across the entire board.

“There is nothing to indicate the market is ready to slow down yet but we are coming into a timeframe where some near-term highs could be made,” said Vetterkind Thursday morning, suggesting that $220 for the August contract could still be possible. “This weekend is going to be big for all the markets in my opinion.”

He also recommended producers continue to buy put options in the feeder market on “cattle that need to be marketed from now until the end of the year at these price levels.”

Though economic crystal balls are still a thing of the future—or dreams, depending on your confidence in technology—there was a word of caution regarding feeder prices for the rest of the year.

“The latest fundamentals from the Economic Research Service have projected prices for the fourth quarter of 2014 below third quarter levels,” reported Matthew A. Diersen, Professor Department of Economics, South Dakota State University, speaking of feeder prices. “Thus, for buyers there is perhaps some relief in sight for prices. However, what could be done if the pattern does not hold? That is a tough call for buyers, as locking in calf or feeder prices today while not also locking in feed costs leaves buyers open to feeding margins changing. If they wanted to protect against a counter-seasonal move, then buying call options would be a way to approach it. For sellers, methods are more straightforward. One may be tempted to sell or price calves now before the seasonal decline happens. The potential cost of doing so is capping any further gains. Protection strategies are right at the sweet-spot where seasonally prices are high and volatility remains low.

“Remember, if you will be buying protection and volatility increases with corn price uncertainty, then options become more expensive. In mid-June the implied volatility in the November feeder cattle futures was at 11.5 percent. That is a little higher than in June of 2013, but well below the 17 and 18 percent seen in other recent years. Buying put options provides downside coverage while leaving the upside open to further gains. Sellers of stockers and calves have another alternative this time of year—Livestock Risk Protection (LRP) insurance. While it functions like buying put options, the price adjustment factor for calves is an attractive feature. With the high prices seen the past year the volume covered by LRP has reached a record high.” — Kerry Halladay, WLJ Editor

 
 


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