The 2018 Grilling Season Causes A Recovery

About: iPath DJ-UBS Livestock Total Return Sub-Index ETN (COW), Includes: LSTK, UBC
by: Andrew Hecht

June cattle get ugly in early April.

Hog futures make lows at the same time as cattle.

Two reasons for selling.

Peak demand season is here in the futures market.

Tariffs and feed prices will determine the path of prices.

Each year, the peak season for animal protein demand in the United States runs from Memorial Day weekend in late May through the Labor Day weekend in early September. Americans celebrate the summer season with what has become a great tradition for family and friends, as they roll out and spark up their barbecues and slap those burgers, hot dogs, ribs, sausage, and chicken on the flames. When one thinks of the summer season, the smells of sizzling meats on the grill often comes to mind.

Carnivores are now preparing for the summer vacation season from work and school which will commence in just one month. Coming into the season where prices typically move to the upside in preparation for increasing consumption, meats have gone the other way this year as prices fell to the lowest levels since the end of 2016 in both the beef and the pork market. However, over recent sessions, we have seen prices come back a bit as the power of seasonal demand caused a bounce from the lows.

June cattle get ugly in early April

In the live cattle market, the June futures contract represents prices at the start of the grilling season.

Source: CQG

As the chart of June live cattle futures shows, the price dropped like a rock from $1.1890 per pound on February 20 to lows of 97.075 cents on April 4. The last time the price of the futures contract was below the $1 per pound level was back in October 2016 when the price found a bottom at 94.30 cents per pound. Over recent sessions, the beef futures recovered and were trading at just under the $1.05 per pound level on April 23. Cattle got ugly in early April, but so did the price of pork.

Hog futures make lows at the same time as cattle

The price of June lean hog futures traded at a high of 85.85 cents per pound on January 9, 2018.

Source: CQG

As the daily chart of June futures highlights, the price dropped to a low of 70.25 cents per pound on April 4 before recovering to its current level at 76.3 cents on April 23. The nearby futures contract in the pork market declined to lows of 50.475 cents per pound in early April, which was the lowest level since November 2016. In October 2016, pork hit a decade low at 40.70 cents per pound.

Both types of meat are going into the 2018 season of peak demand with a bearish tone because of two factors that have weighed on prices over recent weeks.

Two reasons for selling

Two compelling factors hit the beef and pork markets in March and early April and caused the prices to swoon to lows and the lowest levels since late 2016.

The first bearish issue came from the grain markets when a drought in Argentina at the end of growing season in South America sent the price of soybeans and soybean meal skyrocketing.

Source: CQG

As the chart illustrates, the price of May soybean meal futures rallied from lows of $314 per ton on January 12 to highs of $404 on March 2. The increase of almost 30% in the primary ingredient in animal feed caused some producers to process animals earlier and at lighter weights than if feed prices remained at lower levels.

The short-term phenomenon caused a sudden glut in supplies which weighed on the prices of both live cattle and lean hog futures. When it comes to hogs, production is a year-to-year affair. However, raising a herd of cattle can take two years or more until they achieve weights sufficient for processing into beef products and the short-term glut could turn into a medium-term shortage in the months ahead.

The second reason for the pressure in the meat sector was the threat of tariffs and a trade war between the U.S. and China. President Trump announced $60 billion in tariffs on the world's most populous nation in March and said that even greater tariffs could be on the horizon if the two countries cannot reach an agreement that levels the playing field in trade that creates an environment of "fairness and reciprocity."

China retaliated with tariffs on U.S. products and put pork and beef imports from the United States in their cross hairs. A combination of rising feed prices and the potential of protectionism created a potent bearish cocktail for the meat sector.

Peak demand season is here in the futures market

The recent bounce from lows in both live cattle and lean hog futures markets are likely the result of the approach of the 2018 grilling season that commences on the Memorial Day weekend. Domestic consumption of meats will rise in the coming weeks and is likely to remain consistent over the summer months. Economic growth and low levels of unemployment combined with tax reform will give consumers more disposable income in coming weeks and months. With more money in people's pockets, barbecues are likely to be sizzling this summer which should have a positive impact on demand.

We are likely to see lots of volatility in the meat futures market over coming days, weeks, and even months. Peak demand is one thing, but the tariffs and feed prices remain significant factors for meats that could drive prices higher and lower.

Tariffs and feed prices will determine the path of prices

Tariffs will increase U.S. supplies and create glut conditions in the pork and beef markets. However, while higher feed prices is a bearish development on a short-term basis, it could drive the price of beef much higher next year at this time if herds become depleted and supplies decline. Moreover, the U.S. is the world's leading soybean producer, and we are only at the beginning of the 2018 planting season. There is currently lots of uncertainty when it comes to the U.S. crop as the weather conditions across the fertile plains will determine the path of least resistance for prices of all grains.

We have just experienced a half-decade period of bumper crops, but five straight years of sufficient supplies do not guaranty a sixth in 2018. A drought or any other event that limits supplies could send feed prices soaring over coming weeks and months which could create lots of upside opportunity in the live cattle market in 2019 and beyond as consumers will need to wait for ranchers to rebuild herds.

For those who do not trade in the futures markets, Barclay's replaced the COW livestock ETN product with COWB. COW attempts to replicate price action in the livestock markets that trade on futures exchanges.

Source: Barchart

As the chart shows, COWB was trading at the $45.35 per share level on Monday, April 23.

The 2018 grilling season begins in one month, and we should see an increase in the price volatility of live cattle and lean hog futures. As you slap those steaks and ribs on the grill over coming weeks, remember that there is a liquid futures market that is moving all over the place and aside from satisfying those carnivorous urges, the volatile meat sector of the commodities market offers traders lots of tasty opportunities to profit from price variance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.