Fifty cents in your futures

The bottom of the three-year hog price cycle is behind us. I expect hog prices will soar to US$0.45 to $0.50 per pound live this summer with an outside chance of $0.52. This will translate into an Ontario hog carcass price of $162 to $180-a considerably brighter outlook than most forecasts available now, consensus pointing to a seasonal summer rally stalling in the low $40s and dropping into the mid $30s this fall.

My more optimistic price outlook is based on evidence of strong retail demand. Retail pork prices have stayed much firmer than the price of live hogs this winter, indicating that consumer retail demand is quite firm even in the face of large meat supplies. It's reminiscent of 1995, when hog prices rebounded from under $30 (in the fall of 1994) back up to the high $40s by the following summer.

The price seasonals will start improving this month. At this time last year, weekly slaughter numbers started a normal decline.

At the time of writing this article, cash hogs are in the mid $30s, and it's hard to find a reason to believe that hog prices can rally. The list of bearish factors include:

* Hog slaughter is expected nine per cent higher than last year in the April-June quarter (See Hog Wild)

* Per capita consumption of red meat and poultry is increasing 3.5 per cent this year after being flat to lower for the last three years

* Export performance is slack

There are, of course, other events, unpredictable and random, that can affect North American prices almost instantly. The outbreak of foot and mouth disease in Taiwan, Mad Cow disease in Britain, and cholera in Europe are a few of the most recent notable events that influenced our prices dramatically.

With this note of caution, producers needing price protection should consider selling June and July as low as US$63 lean if you don't share my bullish outlook for summer hog prices. I recommend selling June/July futures starting at $68 and scale up if prices go higher. More importantly, getting price protection for October and December hog marketings is paramount. Prepare to sell rallies over $62 on a scale up strategy. This could happen as soon as June if there is lots of optimism regarding hog prices.

The March 1998 USDA Hog and Pig report showed that while the number of hogs and pigs on farms was eight per cent higher than one year ago, the breeding herd increase was restrained, only gaining two per cent. Productivity per sow continues expanding, with an average of 8.68 pigs per litter for the December-February period, up from 8.61. Pigs saved per litter by size of operation ranged from 7.1 for operations with one to 99 sows to 8.9 for operations with more than 5,000 pigs.

Growth in farrowing intentions is slowing, only three per cent more in the second quarter and one per cent more in the third quarter-in sharp contrast to the eight-per cent increase seen in farrowings this winter.

While it is positive for the profitability of the pork industry that expansion plans are cooling, production for next fall and winter still looks intimidating. With three per cent more farrowings and a two-per cent increase in pigs per litter, production could exceed the previous all-time high set in 1994 by three to seven per cent.

Feed Costs
Weather, both locally and globally, will be the determining feed price factor this year. Local growing conditions affect basis, while global new-crop supplies will affect the Chicago price.

Since 1995, the U.S. producer has had much more freedom to plant crops according to market conditions instead of government programs. Before 1995, grain (food and feed) was held in reserve when prices fell and released when prices rallied.

Without this program in place, prices can go higher during periods of shortages and lower when supplies are adequate. With the higher prices seen in the last two years, foreign production has risen to meet the new demand, and will help to cushion the effect that any future weather problems might have on feed prices.

If you have concerns about your feed costs and need protection against higher prices, then seriously consider buying "out-of-the-money" corn call options.
Kevin Simpson is a futures and options broker for Midland Walwyn. 1-888-417-4459. The views expressed are those of the author and not necessarily those of Midland Walwyn Capital Inc. The information contained in this report is believed to be reliable, however we cannot represent that it is accurate or complete.

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U.S. yearns for price discovery

As the Ontario pork industry ponders dismantling its single-desk marketing system, producers to the south look for ways to build one

By STEVE MARBERY

Price discovery - It's a hot topic in Ontario as producers debate the future of their pork sales monopoly. South of the border, the concept has gotten little public debate. But that's starting to change, as U.S. producers seek marketing clout their neighbours to the north have had for almost six decades.

According to U.S. reports, a surge in contracting has prompted interest by government price trackers in the U.S. Late March, the United States Department of Agriculture's Grain Inspection, Packers and Stockyards Administration announced the opening of a Des Moines office to monitor pork industry marketing behaviour.

The authority is also seeking public comment on a regulation that would make it illegal to buy or sell livestock unless the price is reported publicly.

U.S. Senator Tom Daschle of South Dakota has sponsored legislation to require price reporting of livestock sales and protect whistle blowers.

Similarly, legislation has been introduced to the U.S. House of Representat ives calling for companies to bargain with grower organizations during contract discussions. It began in response to broiler grower complaints in an industry that has been integrated for more than 30 years. Contracting is still new to pork.

Sensing the need for price discovery information, the Packers and Stockyards Administration has been quietly investigating midwestern hog marketing trends. According to Washington, D.C.-based deputy administrator Harold Davis, the agency is probing procurement practices to ascertain the impact on pricing and the movement of hogs.

The agency's first report on hog pricing trends is expected this year. The agency, which monitors agricultural marketing in the U.S., has also opened a new midwestern office.

Under U.S. law, packers must prove a cost disadvantage or undercapacity if they reject hogs, but it hasn't been enforced since the early part of the century, say critics such as the National Farmers Union.

The U.S. pork industry may be at the point where small producers are being unfairly restricted from markets, says the NFU. Reports of small producers waiting for two days or more to sell country hogs are increasing. Buying stations (sales yards) are closing at a brisk pace, despite surplus hogs.

Packers are closing stations for practical reasons, since they may have filled entire shifts with large producer contracts. It costs packers about 50 cents per cwt to maintain buying stations, according to an analysis by Chris Hurt, Purdue University economist.

Equally troubling to small U.S. producers is the changing price structure. If only 20 to 30 per cent of hogs are bought on the open market to set the base price, what are the real hog values? The other 70 to 80 per cent of transactions go unreported. It's the classic definition of a "thinly-traded market."

"Apparently, the cost of open market exchange of hogs and pork products is beginning to become excessive, as evidenced by the increase in contracts and integration," says Brian Buhr, University of Minnesota agricultural economist.

While integration could improve pork- industry efficiency by reducing costs, the key question is - Whose costs are being pared? "The obvious capital requirements for integration lead to consolidation and market control by a few large players," says Buhr.

"This has implications for pricing competition. Typically, fewer participants leads to predatory pricing at the expense of the individual enterprise with the least market power....In most cases, an efficient, open market is the best defence."

But reliance on spot markets to set prices in a lightly traded bidding structure can give a few players the power to influence prices, Buhr says: "Unfortunately, the packing industry has a rather dubious history in this regard."

As the sector shifts from a public marketing structure, price transparency wanes, Buhr believes. Traditionally, commodity markets have been considered "perfect markets," because they represent many buyers and sellers, he says.

The hog business is departing from the historic commodity orientation, however. Gone are the days when free entry and exit were assured and capital was not a constraint.

Producers today have difficulty finding and evaluating "appropriate information." The value of general information is declining, as packers pay based on specific carcass traits and often set prices via private negotiations pegged to quality.

Buhr calls the phenomenon "asymmetric information." In other words, the seller or buyer has better information than the other. In packer carcass grids commonly used to pay premiums or discounts, for instance, packers can generate quality information unavailable to the typical seller, because they maintain detailed data on customer hogs.
Says Buhr: Unreported, closed data creates the potential for "unfavourable terms of trade."
Steve Marbery is PORK's U.S. correspondent, based in Mt. Pleasant, Iowa.
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Attrition, American-style

The exodus from U.S. hog farms continues, with an odd wrinkle While the U.S. pork industry is preoccupied with the environment and low prices, a strange thing is happening: Hog prices are bulging, contracting is surging and country markets are closing as fast as small producers are quitting.

Despite good prices in 1996 and the first half of 1997, 25 per cent of U.S. hog farmers have departed in the past two years. Producers are retiring early or taking off-farm jobs rather than building debt. (See Flying South.)

Nonetheless, the U.S. breeding herd is expanding: unchanged from December, and two per cent higher than one year ago.

Small farmers have little impact on the big picture. It's estimated the largest 20 hog firms control up to one-third of the breeding herd. Two companies own 40 per cent of the slaughter capacity: IBP and Smithfield Packing. Six companies control 75 per cent of the slaughter.

The top three packers now contract at least 40 per cent of their hogs, and IBP plans to hit 60 per cent within a year.

A possible explanation for the surging U.S. herd is new contracts, demanded by banks, which tie in new barn financing. The producer gets a line of credit when prices fall below the floor and pays down debt when they go back up. IBP's "cash flow assistance program," for instance, protects against price fluctuations and provides loans at prime minus one.

University of Minnesota agricultural economist Brian Buhr estimates that up to 60 per cent of U.S. hogs are contracted. Producers should be careful with the fine print and even consult a lawyer, he cautions: What happens if contracted hogs come down with porcine reproductive and respiratory syndrome? Some contracts allow packers to terminate agreements if "financial circumstances" dictate, he says.

Survivors, however, seem resolved to supply agreements, Buhr says.

Meanwhile, with diminishing numbers of buyers and sellers, "it is difficult to establish prices in the traditional bid-ask framework," he says. Publicly quoted spot prices represent less than one-third of hogs sold in the U.S., down from 86 per cent in 1993. -Steve Marbery

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