HUNTIN' DAYLIGHT -- RECORDS KEEP FALLING BUT...

by: Wes Ishmael

If cattle prices were equivalent to profit, everybody and their brother would be knocking down the gates to get in the cattle business.

Consider the week of March 7 when cash fed cattle prices exploded $5-$6 to a record highs of $118-$119 (dressed prices $9-$10 higher at $190) as short-bought packers fought to fill rails. The previous high was the $108.80 blip on the screen in October of 2003 when U.S. exports were filling the void left by Canada's BSE problem and just before BSE was found in the U.S.

“This earthshaking event totally reaffirmed cattle feeders' confidence in their recent feedlot replacement purchases, and in any question of the competition within the industry,” explained analysts with the Agricultural Marketing Service at the end of that week.

Along the way, calf and feeder prices, as well as their future markets counterparts have continued to bounce through a stratosphere many dared to even imagine.

Supply, of course, is the driver. The January 1 cattle inventory confirmed what folks already knew—numbers are down. What surprised some was the degree of decline on the beef side—two percent fewer cows and five percent fewer beef replacement heifers.

     

Costs create Expansion Hesitation

When cash fed cattle stretched to $103 a little while back, a long-time cattle feeder told me, “We'd better hope that's a plateau and not the peak.”

He was alluding to the pace at which input costs continue to increase.

As Glynn Tonsor, agricultural economist at Kansas State University explained at the K-State Cattlemen's Day in early March, “Fed cattle prices are expected to generally increase throughout this year, but profits won't necessarily rise or set historic records because of higher corn and feeder cattle prices.”

According to Darrell Mark, agricultural economist at the University of Nebraska, in the March 14 In the Cattle Markets, “The strength of the fed cattle market has kept feedlot operators actively placing cattle on feed through this winter. As projected margins on placements eroded through February, it appears like placements last month slowed compared to that of the last several months. However, the (March) Cattle on Feed report is likely to show an increase of around two percent in February placements compared to last year. Partly this reflects cattle feeders' willingness to buy cattle on the come given current closeout profits and lack of cattle to place later this year. Additionally, increased imports of feeder cattle from Mexico last month resulted in more placements in the Southern Plains.”

High feedlot placements through the fall, as well as auction and direct-traded calf and feeder receipts suggest producers continue to exploit current prices by pulling cattle forward to market earlier.

“Cattle will be pulled forward rather than the more typical pattern until the aggregate beef cow herd increases to a level at which enough calves are produced to halt pulling feeder calves forward for placements—which may not occur until 2013 or 2014,” say analysts with the USDA Economic Research Service in February's Livestock, Dairy and Poultry Outlook. “This scenario could be tempered somewhat by fed cattle prices that will not cover feed and feeder cattle costs—a possibility later this winter and spring—or if corn prices go higher.”

What's Real?

Speaking to the wariness many producers are expressing amid record-high cattle prices, Derrell Peel, extension livestock marketing specialist at Oklahoma State University explained last month, “The point is that there are some very solid reasons why we are seeing record cattle prices and still have expectations for even higher prices. Limited cattle numbers, high grain prices that temper carcass weights and the need to reduce heifer and cow slaughter all suggest that supplies will tighten significantly in 2011 compared to recent years.”

Peel explains current supply fundamentals, the major force in the price explosion, have been unfolding since the early 2000s, when drought conditions across a significant portion of the United States extended the last major cyclical herd liquidation.

“Bovine Spongiform Encephalopathy shocks in 2003 pushed the industry to new levels of intensity with tight feeder supplies offset by placing ever younger and lighter cattle into feedlots,” Peel says. “This reaction worked well as long as corn was cheap.” By 2004, prices had reached a level that resulted in limited herd expansion in 2004 and 2005. In 2006, the world marketplace changed with grain prices jumping to new levels, which have continued fundamentally higher and provoked long-term beef industry adjustments that continue.

Peel points out the loss of profitability caused by high and volatile input prices since late 2006 also prompted additional liquidation, which has contributed to today's extremely tight cattle inventory numbers.

“A continuation of strong export demand and indications of recovery in domestic beef demand will allow cattle and beef prices to move higher. Just how high? No one knows,” Peel says. “…the key is demand and just how much higher prices can be supported. As is typical, the market will probably overshoot at some point and pull back a bit to reveal what the top really is. It does not appear we are close to that level yet and even when we do, we will likely stay at historically high levels for some time. The situation that led us to this point has been a decade in the making and will not unravel very quickly.”

Writing in his weekly marketing comments in March, Peel says, “…Certainly high feed prices will likely be a challenge for the foreseeable future and energy costs are rising with all the associated impacts, especially higher fertilizer prices. However, agricultural producers have always had more opportunity to influence profitability by managing costs than changing market prices for the products they sell and the situation is no different now. Rising input prices mean that producers must make adjustments; sometimes by changing the level of input use and sometimes by changing the entire production process. Cattle have enormous flexibility to adjust the production process in the face of changing input costs. It takes a willingness to think a bit more broadly and recognize that many of the old rules of thumb may not apply anymore.”

Obviously, that's not to say dynamic differentials don't exist. Consider the Choice-Select spread. A higher average percentage of cattle grading Choice and the continuing premium for end meats versus middle meats has turned it on its head.

LMIC analysts pointed out that according to USDA data for the first seven weeks of 2011, 65.7 percent of carcasses graded Choice and 25.9 percent Select. “One year ago those same percentages were 63.6 percent and 27.6 percent for Choice and Select, respectively,” they say. “…The five-year average from 2003-2007 shows a much different picture than today when for the first seven full weeks of the year the percentage Choice was 54.8 percent and Select was 34.5 percent.

“Proportionally more Choice and less Select beef caused the value of those two quality grades at the wholesale level converge. For the week ending March 5, 2011 the Choice boxed beef cutout value was at a weekly average premium to Select of $0.61 per cwt. One year ago that premium was a bit larger at $1.40 per cwt. However, the 2003-2007 average was much larger at $6.59.”

As always, the long-term fundamental also cannot account for the short-term variation. Most recently, that comes in the form of the devastating earthquake and Tsunami in Japan. That nation is the world's third largest economy and a primary destination of U.S. agricultural exports like grain and beef.

All things considered, though, this statement of Peel's rings loud and clear: “The basis for cattle industry expansion is solid and I expect the market to continue offering incentives to cow-calf producers in the form of high calf prices. Eventually, producer expectations will change and producers will make the investment in heifers. Producers who act sooner rather than later will enjoy more of the value the market is offering now.”







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