ALL-TIME HIGHS IN JULY: Hogs and Cattle

We booked a fifth consecutive gain on the long-side this week in livestock (ETF: COW) after buying on the oversold signal late last week. 

ALL-TIME HIGHS IN JULY: Hogs and Cattle - Levels chartvF2

Between the cattle shortage in the United States, scandal in China, and PedV virus affecting some 4,700 farms nationwide, both markets have skyrocketed to all-time highs this year amid a longer-term trend of much higher meat prices:

Five year changes:

  • USD Index: +5%
  • Live Cattle: +88%
  • Lean Hogs: +115%

While both have run significantly this year, a price divergence has emerged between the two over the last month. Basis between front and 4th,5th,6th contract months suggest the market expects much lower prices for both by next summer:

  • Lean Hogs: +38% YTD but down -11% over the last month. Spot-Feb basis is implying -25% lower prices by February
  • Live Cattle: +19% YTD and up +5% over the last month. The basis between the two months is not quite as high. The Spot-Jun 15’ basis is implying a -5% price decline by next summer

The USDA extended a conditional license to utilize a vaccine for the PedV virus that usually kills 100% of the baby pigs in an infected farm. Harrisvaccines in Ames, Iowa is responsible for developing the vaccine and will be allowed to test its effectiveness. The market has reacted to its positive outlook. Lean Hogs spot contracts are down -12% since the news broke on the 15th of July, and the forward curve flattened. The vaccine is expected to be tested on the sows with the hope that they build the anti-body to disinfect the milk passed along to piglets. Despite the sell-off in hogs:

  • Put implied volatility right at the money is priced relatively flat vs. its 1 and 3 month averages and 15% above its 6-month averages. As expected the upside skew was immediately flatter on the PedV vaccination news (implied vols for the far out of the money call options were selling about 3-5 vol points lower). Sentiment as measured by the net length of futures and options contracts has remained flat on back of the news. 

ALL-TIME HIGHS IN JULY: Hogs and Cattle - Basis Graph in Hogs 

Supply disruptions in livestock year-to-date have led to a divergence from some of the more observable correlations in the commodity complex our team has flagged to support our big-picture macro themes. The negative correlation to the dollar is not AS pronounced in Hogs and Cattle, but the strength of the dollar is always a catalyst for the consumer (and thus everything priced in dollars).

With a seemingly improving labor market, a pull-back in commodity inflation, and the increase in revolving consumer credit, we need to continue seeing sequential improvement in these three areas for evidence of material improvement in the consumer spending picture. The livestock market is certainly expecting a pullback....   

ALL-TIME HIGHS IN JULY: Hogs and Cattle - Lean Hogs Futures Curve

ALL-TIME HIGHS IN JULY: Hogs and Cattle - Live Cattle Futures Curve

ALL-TIME HIGHS IN JULY: Hogs and Cattle - USD Correls

ALL-TIME HIGHS IN JULY: Hogs and Cattle - 1 Month Correls

ALL-TIME HIGHS IN JULY: Hogs and Cattle - 3 Month Correls

ALL-TIME HIGHS IN JULY: Hogs and Cattle - 6 month correls

Hog prices have outpaced cattle YTD, +38% YTD and +19% respectively, but as mentioned, the market has converged over the last month. Lean Hog spot reached a high of $133.80 USD/lb. on July 15th and has since pulled back over -10%.

Yesterday marked a YTD and all-time high in cattle prices ($159.85 USD/lb.) A few of the outliers potentially fueling the move are included below. (Note: We’re looking to the market for buy signals in these commodities without edge on a fundamental call moving into the fall at this point):

  • July 23rd: OSI Group’s Husi Food Scandal
    • After a Shanghai reporter secretly filmed the packaging practices of a  Shanghai processing plant, the Shanghai Municipal Food and Drug Administration (China’s FDA) investigated and uncovered a number of alarming practices including:
      • Repackaging expired food (at least 4,300 cases)
      • Unsanitary packaging practices
      • The brands affected include McDonalds, Starbucks, and YUM Brands. Most chicken and beef products served at McDonalds in northern and central China are now unavailable. All companies have severed ties with Husi
  • January2014: The USDA reported a cattle herd at a 61 year low, possibly due to a number of factors:
    • Increased demand for organic meat
    • Biggest drought on record in California (spread from to Texas)
    • Supporting younger calves through a major drought and extremely cold winter in the Midwest makes having cattle uneconomical for farmers
  • April 2013: The USDA reported the PEDv virus was now in the U.S. It also estimates over 7M pigs have been killed in the past year, affecting 4,700 farms in 30 states. The mortality rates among young pigs is nearly 100%. Year-over-year, consumers are paying nearly 13% more per year at the super market     

Ben Ryan

Analyst