When Looking at Beef Futures, Know Your Cattle

Ah, the good old days. It seems like just last June, the U.S. top meat producers were Cargill, Tyson (TSN)), Swift, National Beef Packing and Smithfield Beef. Not exactly brand names in the minds of consumers, but since the last wave of consolidation in the '80s and '90s (where the top-four meat-producing companies went from handling 36% of all cattle slaughter operations to controlling 78% of the market), it's at least been stable.

But then Brazil's JBS started its buying spree. In June last year, Latin America's largest beef producer gobbled up Swift & Co., the United States' third-largest beef processing company. Not only did this get them a foothold in the U.S., it made them the world's largest meat producer overnight - ahead of Tyson and Cargill. And it looks like the big will just keep getting bigger. This week, JBS announced its intentions to buy National Beef Packing Co., as well as the beef processing and cattle feeding operation arm of Smithfield Foods Inc.

Ginormous deals like this are never a foregone conclusion, and there are mixed feelings on how this consolidation is going to affect the market. The Bull Bulls believe that it will be good in the short term because the beef processors will still need to compete for cattle. The Cow Bears believe this is putting too much of the industry under one company's control - especially since the Smithfield deal includes its share of Five Rivers Ranch Cattle Feeding, the world's largest cattle feeding company. This potential consolidation comes as the profit margins of meatpackers have been squeezed because of the tight cattle supplies and lower production.

And for the futures market?

If you're just dipping your toe in the water, you first need to understand the different contracts: Live Cattle and Feeder Cattle. The difference is simple: how big your cow is, and where he lives. To qualify for the Live Cattle contract, Bessie has to be somewhere from a calf to about 600 to 800 pounds. Once that little guy hits that target weight, he gets sent off to the feedlot. Once at feedlots, cattle are classified as Feeder Cattle. Feeder cattle stay in feedlots for about three to five months while being fed corn and other grains to bring their weight to an average of 1,250 pounds at slaughter time.

These two contracts have very different seasonal cycles:

 

Feeder Cattle Weekly Prices

Live Cattle, Weekly Prices

But even without this seasonality, livestock prices have remained relatively flat while other "soft" commodities have seen huge increases in the past few years. So what's really moving prices?

Weather

Extremely hot weather or extremely cold weather can affect the normal growing patterns of cattle. Extreme heat can cause cattle to eat less and therefore gain less. Extreme cold stresses the animals and they use more energy to survive instead of packing on the pounds. Both extremes result in less weight gain and lower prices for cattle. Droughts also have an effect on cattle prices as farmers have to worry about how many head of cattle their pastures can support during times of drought. If the weather math doesn't work, farmers can decide to send excess cattle to slaughter ahead of schedule in order to save what cattle they can, or not breed as many cattle for the next year or so, to ensure sufficient pasture lands for existing cattle.

Grain Prices

Of course, recently the big issue these days has been the price of feed for Bessie. High corn prices equal higher costs of producing beef because of increased feed costs at feedlots. If you own the feedlot, you've only got two ways to go. You can feed less to the cow (skinny cows = low prices), or you can feed fewer cattle. Fewer cattle means either "buy fewer cows" or sending some off to the slaughterhouse early. Paradoxically - and this might explain recent trends - this means that high corn prices can result in lower beef prices for consumers because there are simply more cows coming to the market. The effect is temporary, but real.

The cattle industry isn't like the oil industry where if the cost of producing the oil or transporting the oil to market gets so high that it is no longer cost-effective, you just shut down the oil field. You have to actively do something with the cattle - you either feed them or slaughter them. High grain prices also influence breeding practices. If a farmer knows that the feedlots are paying less money for cattle, he might decide not to breed as many of his heifers in order to reduce the costs of raising calves for market.

Disease

Mad cow disease, or bovine spongiform encephalopathy [BSE] as it is more properly called, can influence prices in the short and long term. Most rational investors assume this is panic selling on rumors, but legitimate cases can cause rapid price and demand drops that are tough to shake off. The market is still recovering from the 2003 scare that resulted in countries like Japan banning U.S. beef imports.

Industry Reports

The most watched report in cattle futures circles is the Cattle on Feed Report - and if you're a cattle investor, you should be watching it too. It supplies statistics on the number of cattle in feedlots (feeder cattle); placements (the number coming into feedlots); and marketings (the number of cattle going out of feedlots to slaughterhouses). The most recent report was released on February 22, 2008, and showed that U.S. cattle on feed is up 2% from last year, and at the second-highest level in the last 12 years. Placements have risen 6% from 2007 and marketings are up 1%.

See how that works? High grain prices and past droughts have actually put more cattle coming into the feedlots, and the national cattle herd is essentially not growing. Because of this, slaughterhouses are sitting at 84% capacity, far short of the 92% capacity most analysts estimate is required to break even.

What Does The Future Hold?

As with most agricultural commodities, let's check with the USDA Agricultural Projections: Higher grain prices as well as effects of drought in recent years hold down cattle inventories, pushing U.S. beef production down in 2008‑10. Production then rises in the remainder of the projection period as returns improve and herds are rebuilt. The cattle inventory remains in a range of 96‑99 million head throughout the projections. Rising slaughter weights contribute to the moderate expansion of beef production beyond 2010. Higher costs of feedlot gain will result in stocker cattle remaining on pasture to heavier weights before entering feedlots.

This is assuming no further weather extremes or other supply or demand shocks. With a tight cattle supply, one could expect prices to rise, but economic uncertainty and rising food prices may put a damper on consumer demand, resulting in lower live and feeder cattle prices. And with the uncertainty of major consolidation, this market remains a challenge to navigate. At least until Brazil has had its say.

Links

Beef-Industry Deals Continue WSJ March 5, 2008

USDA Economic Research Service Overview

Comments

[sbenard]

Great article! I have traded cattle futures. Hillary seems to have cornered the market!
I have wondered about the seasonal aspects of the cattle futures, and now, thanks to your article, I have a primer on the subject. Thanks again!

[rx]

The author of this article doesn't know a thing about the cattle mkt. Live Cattle are slaughter ready, Feeder Cattle are of lighter weight entering into the feedlot. Bessie is a Cow, CME mkts. trade steers only! A first year high school jounalism student could do a better job of getting the facts correct!