The cattle markets have endured two major disruptions in the past eight months. Now we’re starting to hear the noise again about dysfunctional cattle markets. And of the packers taking full advantage of the situation. Many folks are starting to wonder what the value of futures markets are anymore. It was created for risk protection, not speculation, but the speculators have gotten a hold of these markets, ignoring any of the fundamentals we typically operate with.
We have a price discovery problem in the fed cattle markets and the futures market just isn’t sending reliable signals; supply and demand aren’t at work here. Every time one of these market routs occur, hedged feeders are content to watch cash fall while they make their money on the positive cash basis, which has been the highest in history. Some feeders were smart enough to lay off some risk and take the reward. I’ve heard wild numbers about how many feeders hedge their fed cattle from 4 to 40 percent. Open interest on feeder cattle is 47,400 contracts; live cattle it’s about 350,000—this isn’t big trade volume. Open interest on corn is generally at 1.5 million contracts.
Cassie Fish at Consolidated Beef Producers said it rather bluntly, “Though long hedgers get zero attention, there are thousands of contracts of fixed long-term ratio basis contracts for multiple beef cuts that are tied to futures. These contracts are hedged by value not pounds. It equals thousands and thousands of futures contracts. Those long hedgers today are getting annihilated on hedges. Fixed price beef ships weekly and hedges are methodically liquidated. Because the relationship between cash cattle prices and futures cattle prices is being destroyed, long hedgers are taking a huge hit.” Now we’re getting really complicated—hedged ribs or loins—how does that work?
We need more price discovery and some folks have talked about tying live cattle to boxed beef values—a new kind of formula. Are we ready for a new method of buying cattle based on real meat value? I understand that some packers have tried this, but nobody understands how it works. Making the market more complicated isn’t going to help.
The formula pricing system is easy to understand. It’s based on the five-state negotiated cash average, which is published twice a day by Agricultural Marketing Service, Mandatory Market Reporting. If you delivered cattle this week you got last week’s five-state cash average. It works okay in a down market, but not so good in an up market.
Some cattle sellers have complained that the cash portion of the formula has been so thinly traded that it gives packers a buying advantage because so few cattle are sold on the negotiated cash market. For instance, Texas might negotiate trade on 5 percent of their weekly sales, while the folks in the Iowa-Minnesota area might have 30 to 40 percent of their cattle sold on the cash market. Therefore, the better Northern cattle are setting the price for poorer quality Southern Plains cattle.
A couple years ago some folks tried to get the cash market going much earlier in the week. That’s when Superior Livestock Auction started the Fed Cattle Exchange. They wanted to get more cash cattle traded earlier in the week to aid in the price discovery method known as the live auction.
The Fed Cattle Exchange held their normal Wednesday auction this last week and cattle sold. Packers haven’t been active in the auction in the past but became active last week. Even packers realize that they need producers to provide them with good cattle. They could have sat things out until the end of the week and bought a lot of cattle at $105. But they didn’t.
Through Wednesday last week 119,765 head sold on the negotiated cash market. That’s huge early week trade and packers paid the asking price, between $105 Monday to $113 Wednesday. With the rapid rise in the beef cutout and the huge windfalls they were making, I honestly think they felt a little guilty buying cattle too cheap, for the second time in a year.
I think we all know that price discovery in the fed cattle markets is broken and needs attention. The cattle futures contracts have a problem, and I don’t know how to fix it. Futures and options can be useful, but they are also confusing. We need to give it a big KISS—(Keep It Simple, Stupid). — PETE CROW
