Where's The Beef?

| About: iPath DJ-UBS (COW)

Record high grain prices have been the focus of the market recently, and a lot of people have been talking about the effects of these high prices on other agricultural sectors and markets. The thinking goes that it will lead to smaller cattle, hog and chicken herds (as the price of the input, feed, goes to records it becomes unprofitable to raise the livestock).

That all makes a lot of sense generally, but what a lot of people don't realize, and missed at the end of last week, is that the cattle herd is already the smallest since the USDA began keep records in 1972 at just 97.8 million head of cattle. Last Friday the USDA released its bi-annual Cattle Inventory Report, and as of July 1st, the amount of cattle in the country dropped by 2.2% from last year, well below expectations.

Given the higher grain prices and this bullish data, you'd expect Live Cattle prices to have rallied hard, but that isn't the case. There are a couple of reasons for that: First, the "Cattle on Feed" numbers showed an increase in cattle at 12.3 million head, up 1% from last year. Additionally, the "Cold Storage" of beef is up year over year as well, and at the upper range of its 5 year average. Finally, these higher corn prices will most likely cause ranchers to bring unprofitable herds (where they haven't hedged out their feed costs) to market early, as they monetize the herd now before it becomes unprofitable to continue to raise the cattle.

But, some of this negativity has to be taken with a grain of salt. The Cattle on Feed numbers are taken only from large feed lots, and as smaller lots have closed over the past several years, they've sold their herds to larger operations-which gives the impression that the number of cattle are growing, but in fact they actually may be falling as the declines of smaller ranchers aren't accounted properly accounted for.

The point is this-that fundamentals for Live Cattle are bullish, and that was before grain prices decided to go absolutely crazy, and these higher grain prices only raise the bullish prospects further.

So, while we may see a temporary dip in Live Cattle prices as herds are brought to market early, the medium term fundamentals are strong and improving.

While the best way to play Live Cattle is through the futures markets, there is an ETN that tracks both Live Cattle and Lean Hogs prices. (COW) is the I-Path Dow Jones Livestock Sub-Index Total Return ETN, and it gives investors without futures accounts exposure to livestock futures. Specifically, the ETN mirrors the returns of a sub-index comprised of 38.95% Lean Hogs futures and 61.05% Live Cattle futures.

So, while it isn't a pure play just on Live Cattle, it does offer investors exposure to Cattle futures. Specifically, despite also having exposure to Lean Hogs futures (which also will benefit from a thinning of the Hog herd) it is a better option than going with a live stock or "protein" company, as margin compression from higher feed prices probably won't be totally offset from the price rise in Cattle futures. It's a classic example of wanting to own the commodity rather than a company that deals in the commodity, because the gains won't be the same.

From a fundamental standpoint, unless we get some serious demand destruction from consumers eating less beef (and I don't think that's going to happen even if we enter another recession) then getting long live cattle futures is one of the more sensible medium/longer term trades out there.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.