Cattle prices are at all-time highs, thanks to a strong 25 percent rally over the last 12 months. Just look at prices over the past 25 years:
You want price strength? How 'bout live cattle futures hitting all-time highs? (Source: Barchart.com)
Several long-term factors have provided a significant, sustained tail wind to meat prices, starting with grain prices. Grains have rallied quite a bit over the past year; the iPath DJ-UBS Grains Subindex Total Return ETN (NYSEARCA:JJG), whose index tracks a basket of corn, wheat and soybeans futures, has risen 59 percent year-over-year.
It takes a lot of grain to produce a pound of beef — roughly eight pounds of grain per pound. Thus any rise in grain prices means it becomes more expensive to feed a cow, which inevitably gets passed along to the cattle buyer. Since 2006, feedstock prices have skyrocketed — and stayed higher — and the elevated costs have forced ranchers to pare back their herd levels to acclimate.
But it's not just bigger input costs keeping herd inventories down. In fact, herds have shrunk steadily since 2004, due to a combination of drought and mad cow disease shocks. Collectively, the 2011 herd is the smallest in 53 years.
At the same time, demand has never been as high. As consumers in emerging markets like China and India become more prosperous, their diets are quickly becoming "more American" — as in, they are consuming a lot more meat. According to Eric Ocrant, vice president of Oak Investment Group, there are three times as many beef consumers now as there were 10 years ago.
Therefore it's clear that, unlike in 2008, this current trend isn't the result of a short-term market shock. Rather, it's more the culmination of a slow, developing trend bubbling up to the surface.
After taking a bath for the last decade, ranchers are now taking advantage of high cattle prices while the going is good. High prices have persuaded many recession-strapped ranchers to sell their stock now, rather than maintain heifers for breeding. A recent U.S. Department of Agriculture report surprised many industry analysts and insiders by reporting a 5.4 percent decline in replacement heifers.
Of course, selling breeder heifers now leaves ranchers with even fewer head of cattle for tomorrow, so prices are likely to keep rising until herd numbers begin to replenish.
Pork Prices Also on the Move
What about the other white meat? Substituting expensive beef for cheaper pork won't work today; pork (which has similar bullish fundamentals to beef) is up 13 percent over the past year:
It's a bull market in lean hogs, too. (Source: Barchart.com)
Ways To Invest in Rising Cattle Prices
We could start by looking at the meat producers -- such as Tyson Foods (NYSE:TSN) or Smithfield Foods (NYSE:SFD) — but like ranchers, these companies currently struggle with higher input prices. Plus, as we've said before, why complicate things by having to also place a bet on management? I'd prefer a purer play on rising meat prices that can't be messed up by a middleman — or middle manager.
The iPath DJ-UBS Livestock Subindex Total Return ETN (NYSEARCA:COW) offers a fairly direct 60/40 split between live cattle and lean hogs. COW looks good on paper (especially since hog fundamentals are so strong as well), but unfortunately, it hasn't been able to capture much of the price rally:
Hey COW, it's supposed to be a bull market! (Source: StockCharts.com)
The UBS E-TRACS CMCI Livestock Total Return (NYSEARCA:UBC) has been better — or at least, less bad — than COW:
UBC has not been a perfect proxy either—though it has at least captured some of the meats' gains of the last 18 months. (Source: StockCharts.com)
UBC has a similar meat mix as COW — a 55/45 mix between live cattle and lean hogs. Unlike COW, which tracks only front-month futures, UBC's index follows a mix of futures contracts three and six months out (although as ETNs, neither product actually holds the futures contracts themselves; they're essentially debt instruments backed only by the good credit of the issuer). Taking the basket approach, however, appears to account for the UBC benchmark's relative outperformance (and I use that term very loosely).
Livestock futures comprise a substantial portion of DBA's futures basket, which allocates 12.50 percent to live cattle, 8.33 percent to lean hogs and 4.17 percent to feeder cattle. Other ETFs and ETNs offer exposure to livestock, including the Elements Rogers International Commodity Index Agriculture ETN (NYSEARCA:RJA), the GreenHaven Continuous Commodity Index Fund (NYSEARCA:GCC) and the iPath DJ-UBS Commodity Index Total Return ETN (NYSEARCA:DJP), but DBA's livestock allocation far outweighs the percentage in any of these ETPs.
Meanwhile, MOO comprises stocks of companies in the agriculture business — and while not a pure play on rising meat prices, it should be on your radar screen as a way to play the broader bullish trends in agriculture:
The "pick-and-shovel" agriculture play MOO has fared much better than COW and UBC of late. (Source: StockCharts.com)
Still, livestock futures themselves — specifically live cattle and feeder cattle futures — remain the most direct and reliable play on rising beef prices. With the meats, the ETNs do not appear to be reasonable-enough proxies for even shorter-term trades — you are probably best off going straight to futures contracts for live and feeder cattle for the most direct investment.
Cattle (Finally) On Board the Commodity Bull
We have rising demand for beef coupled with the lowest cattle herds in 53 years and tomorrow's cattle being sold off today for short-term cash. That's a very bullish combination!
Until herds are rebuilt and/or meat producers begin to hit a wall in terms of pricing power with end consumers — neither of which appears to be happening yet — cattle prices should continue their climb through 2011 and beyond.