Pork Demand is Hog Wild While Supply Squeals

Every once in a while, a press release crosses my desk that catches my eye as something more than a vain attempt by PR flacks to keep their jobs. Maybe it contains some new widget I can get excited about, or maybe it just contains something that makes me think. This time is definitely the latter.

ETF Securities released a press release on June 4, 2008 that had some interesting numbers in it. Numbers like 475% and 2,700%. Now, those numbers look interesting all on their own - but they tell you nothing without context.

ETF Securities is a company that has 120 exchange-traded commodities (ETCs) available on five major European exchanges for investors who are looking for commodity exposure. Those of us in the U.S. have a hard time reaching these markets, but even if you're not buying the HOGS ETC in London, the trends are worth noting.

Even though oil and certain grains (corn) are stealing all of the headline space in the media, the assumption most people make is that the commodities boom is across the board. This is sending investors looking for the hidden gems - those that might catch up with the bull runs we've seen in precious metals, grains and energy in the last few years. Livestock is at least being touted as one such gem.

ETF Securities reports that investments in their ETCs in livestock have risen 475%, from $40 million to $230 million, so far this year. Within Livestock, it looks like Lean Hogs (GB: HOGS) wins the "most popular" award, with trading volume up 2,700% in the last 12 weeks. Interestingly, ETFS reports that they now have $68 million in assets in Lean Hogs, which includes one single trade dropping $40 million into the fund. I guess someone likes bacon!

Why all of the increased interest in livestock? Is it a matter of investors on the lookout for the next up-and-coming thing? A diversification strategy? Or do people really just like hogs? What is making the lowly pig so attractive?

It is certainly not any great gains in the last few months.

Lean Hogs Daily (LH, CME)

Lean Hog contracts have been chugging along between 70 and 78 cents a pound since April. But the picture changes as you look at longer data.

Lean Hogs Monthly (LH, CME)

Now we're getting somewhere. With volatility, there is always the chance of making a quick buck - provided you've got your crystal ball in working order.

The price for lean hogs is currently on the higher end when you look back over the data of the past eight years. But companies have been losing money - a lot of it. Months of hog prices below the estimated break-even price of 60 cents a pound have had some serious effects.

Smithfield Foods, the world's largest pork producer, recently reported a drop in profits of 94% in its fourth quarter due to high feed (read Corn) and energy costs (read Oil). Losses like that are going to make companies reduce production in order to cut costs, and the USDA agrees. According to the USDA's World Agricultural Supply and Demand Estimate report released just Tuesday, production of hogs for 2008 and 2009 is going to be lower than previously expected. Imports are also expected to go down, especially from Canada as they slow their production as well. The animals that are slaughtered are also expected to be slightly skinnier, as farmers don't want to pay to feed the hogs for as long as usual. The hot topic among pig farmers these days is how to fatten up the pigs while not buying $4 corn.

This all adds up to an expectation of lower supply in the market.

At the same time, demand for the meat in countries like China continues to grow. Imports by China had already risen a reported 900% in the first four months of the year. The recent earthquake in China killed over 3 million pigs, which also translates to more imports both in the near term as pork demand is expected to rise for the Olympics, and in the longer term until China can replace lost capacity.

So, outside of skyrocketing feed and energy costs to the producer, the picture looks rosy - lower supply and higher demand means the other white meat is going to get a bit more pricey, thus the press release. But is the picture rosy enough to explain all of the increased interest?

The interest in Lean Hogs can be summed up in a press release quote by ETFS' Chief Operating Officer Nik Bienkowski:

"Livestock ETCs have not been correlated to precious metals or agriculture and this provides additional diversification benefits."

Here is a table looking at the past years' data and correlations.

Correlation? What Correlation?   Lean Hogs Corn Oil MSCI Gold Lean Hogs 1.00 0.07 0.05 0.06 (0.35) Corn 0.07 1.00 0.89 0.93 0.85 Oil 0.05 0.89 1.00 0.99 0.80 MSCI 0.06 0.93 0.99 1.00 0.83 Gold (0.35) 0.85 0.80 0.83 1.00

And there we have the conclusion. Looking at the daily returns over the last year, it would be difficult to find a less correlated asset for a commodities investor than Lean Hogs. This is one of the fundamental premises of commodities investing: finding uncorrelated assets.

Dwindling supplies. No evidence of slacking demand. Zero (or negative) correlation. And suddenly the press release makes sense.

Comments

[onlytrusthim:]

CAn you give some additional live stock EFT symbolls that may be a good investment?

2008 Jun 17 09:40 AM

[drmalaka:]

I have been thinking about starting a position in meat of some sort and figured that beef was good but this works just as well. I have read quite a bit about farmers slaughtering their herds to limit costs of feed. With a bad corn season already underway feed is going to get even more expensive and there are going to be fewer animals to slaughter next year.

2008 Jun 17 11:23 AM

[Mark Anthony:]

Good article. Unfortunately it is hard to invest in live hogs. There has been a recent paradigm shift event few people noticed. And that make one of the little know precious metal a very bullish commodity play. Read it here:

seekingalpha.com/artic...

In short, it all relates to the Russian strategic stockpile of a critical metal.

2008 Jun 18 01:45 AM

[User 7918:]

There are ETNs (exchange traded notes) that allow you to invest in the livestock commodity. The symbol is LSO. For more information go to the web site: elementsetn.com.

2008 Jul 16 05:56 PM

[Timothy Plank:]

Nice article. AgFeed (Sym: FEED) is an excellent play. Company listed on Nasdaq that produces Hogs and hog feed in China. Excellent balance sheet, good management and fantastic growth in revenue and profit. Take a long hard look at it if you're looking for value in this sector.

Apr 24 08:43 PM