Market Preview
Differentiating Marketing Agreements
There seems to be quite a bit of activity in the market for marketing contracts at present. No, you didn't see double in that sentence, and I actually wrote what I intended to write. Allow me to elaborate.
There is a market for contract hogs just as there is a market for negotiated hogs though there are, of course, some important differences.
The market for negotiated hogs involves relatively immediate shipment, while the market for contract hogs involves commitments to deliver pigs periodically over a period of time.
Negotiated sales are almost always one-time deals on a load or a few loads of hogs, while contract deals are one-time negotiations on the terms of trade for several months' or even years' worth of hogs.
The price of negotiated hogs is mainly dependent upon current pork demand and the supply of non-committed pigs, while the price of contracted hogs is usually a differential from the future spot market for either hogs or pork. That differential is key, though, as it may be larger when packers are actively seeking to lock up supplies, and smaller when producers are actively trying to assure shackle space. Supply and demand still work, but they work differently here.
The market for negotiated hogs is more or less always there while the market for contract hogs comes and goes. Part of that is due to so many hogs going under contract in the mid-1990s. After that flush, there wasn't nearly as much contract activity for a few years until those contracts began to expire. We're now in the second or third round for many producers and, since the contracts' lengths were not all the same, there is more of a steady market for contracts though it is still rather "lumpy" across time.
A major driver of the current activity is, I believe, the pending opening of producer-owned Triumph Foods in St. Joseph, MO. That addition of 8,000 head/day to U.S. slaughter capacity will quickly draw owners' pigs away from their current destinations, leaving other midwestern packers quite interested in securing long-term supplies.
Negotiate Contracts Carefully
Producers need to do their homework as they negotiate. Price relationships change over time and what once was an appropriate valuation formula may no longer be.
Such is especially true of cutout values. Figure 1 shows weekly data on two well-known hog prices, and the USDA cutout value since August 2001, when the confidentiality problems with the Mandatory Price Reporting System were resolved.
Note that the relationship between the National Net price and the Iowa-Minnesota Base Price is pretty stable, but that the relationship between both of those and the cutout value changed markedly in mid-2004. Prior to May 1, 2004, the National Net price averaged 89% of the USDA cutout value. Since that date, it has averaged 98% of the cutout value. The average for the entire period from August 2001 through last week was 92.5%.
Now add in the fact that USDA will change the cutout value computations in January 2006. The changes are necessary to make the cutout value representative of leaner, heavier-muscled hogs and modern trimming and processing methods. They are certainly not intended to "screw things up," though that is one result any time a price series is changed. USDA's survey of packers found, in general, that yields of trimmed wholesale cuts have increased. These increases will result in a cutout value about $2/cwt carcass higher under the new computations. Add $2 onto the cutout value since May 2004 and the average hog-to-cutout percentage is 95.6. That's not 98%, but it is still much higher than either the long-term average or the average prior to May 2004.
And one more thing -- USDA has announced that it will not publish a cutout value if it does not have recent price quotes on all of the major wholesale cuts. So, if skin-on bellies sell one day in a week (which is common), there may not be a published cutout value on the other days.
While cutout-based pricing theoretically gets producers closer to the end-user and puts packers and producers on the same side of the meat market, its use is rather complicated at the moment. That doesn't mean you shouldn't do it, it but it does mean you should be careful to look at all of the implications.
Hog Market Hangs Tough
The hog market has held up well the last couple of weeks in spite of a large slaughter run last week. The first week of November 2004 was the biggest slaughter run of the year except for the week prior to Christmas. We are hearing that packers are reducing Saturday slaughter plans and the most recent weight data indicate that producers are pretty current in their marketings. A market observer that I think knows what's going on said this week that this market "feels pretty good." One of those real scientific observations, huh?
But that's how it feels to me, too. Contract life highs in the June through December Chicago Mercantile Exchange Lean Hogs contracts and February and April contracts suggest that there is still some upside to the futures markets, and add to that feel. While things aren't nearly as good as a year ago, they aren't bad at all.
We will all have much for which to be thankful for again this year, so go buy a big ham soon.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com
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Production Preview
Privatization Is Better
Three things happened recently that got me thinking. I took a trip out of the country and used my bank debit card to get cash at a foreign bank. I stuck in my card, put in the four-digit code, and within 11 seconds the information about me was transmitted to my bank. The fact that the funds were available was transmitted back, and I had my cash, even though it was at a less-than-desirable exchange rate. I admit I got slightly impatient waiting the 11 seconds.
When I returned home from that trip, I ran into a friend who showed me the forms she needed to fill out for her father to enroll in the new Medicare prescription drug plan. The forms and instructions were almost an inch thick, and written in the language style known only to exist in "beltway bureaucratic circles." The forms looked to be virtually impossible for many of the target customers to understand and complete properly. If any of you have helped your parents complete these forms, you know what I mean.
A few weeks ago, the U.S. Department of Agriculture (USDA) sponsored a listening session in Kansas City, MO, on the privatization of the animal movement database for the National Animal Identification System (NAIS). The privatization of this portion of the NAIS is the result of a decision announced by USDA Secretary Mike Johanns in August of this year. When making the announcement, the innovation of the private sector was noted as one of the important reasons.
So what do these three situations have to do with each other? Maybe nothing, but here is how they got linked together in my head.
The first is an example of a private sector network of distributed databases linked together along a common portal. The system is one that works and in which people worldwide trust with their money. The second is an example of what can happen to a relatively simple program in the hands of our federal bureaucracy. The third is a wise decision that assures ultimately, the complex network of animal movement databases and a common portal will, in fact, be functional and not burdensome to its private-sector users over the long term.
At the meeting in Kansas City, the message delivered loudly and clearly was that the industry needs to get together and work this out. The participating parties need to form an entity that will enter into a Memorandum of Understanding with the USDA to deliver the animal movement information they will require. State veterinarians also expressed concerns about the private system and what they need from such a system. Reliability, access, and robustness were all mentioned as required elements. From my point of view, all three terms describe the network of distributed bank databases and the common portal accessing them. On the other hand, none of those terms describe the Medicare program. I believe that, as an industry, we will be happy with this decision, and the resulting system will deliver more than anyone can imagine that will benefit the industry.
In the meantime, there is much gnashing of teeth going on because no one likes changes. We are all especially reticent to changes that appear to have happened midstream. In addition, there is a general perception that one industry player may have had a big influence on this decision, and there is some degree of jealousy over that perceived influence. The level of frustration in the room was palpable and understandable.
However, the decision has been made. Congress recently had an opportunity to overturn the decision but decided to allow it to stand. In my opinion, continued pushback and attempts to return to what we all thought was a plan for a federal animal movement database are not productive at this time. I believe the industry leaders that were once able to work together to complete the plan that is the basis for the NAIS can and should get together, check their egos at the door, and develop a plan to make this system work.
David Farnum, DVM
dfarnum@veriprime.com
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Legislative Preview
Japan Rules U.S. Beef Safe
Japan's prion committee ruled the risk of bovine spongiform encephalopathy from U.S. beef is "extremely low if proper precautions are taken." The panel forwarded its report to Japan's Food Safety Commission (FSC). The FSC accepted the prion committee's recommendations and have announced a 28-day comment period. This is a major step forward in efforts to reopen Japan's market for U.S. beef. The prion committee chairman, Yasuhiro Yoshikawa, said, "Based on the assumption that all precautions are taken as requested, we consider the difference in risk between U.S. and Japanese beef to be extremely small." President Bush and Japanese Prime Minister Koizumi are to meet in mid-November, and reopening the border will be a major topic of discussion. Japan closed its border to U.S. beef in December 2003.
House Agriculture Committee Approves Cuts -- The House Agriculture Committee passed its budget reconciliation package recently, which includes $3.7 billion in cuts in farm, conservation, research, rural development and food stamp programs over five years. The cuts include:
Direct payments for farm programs are reduced by 1% for the 2006-2009 crop years.
Advanced program payments are reduced from 50% to 40% for 2006-2007 crop years.
Step 2 upland cotton program eliminated on Aug. 1, 2006. The World Trade Organization ruled against this program earlier this year.
Conservation Security Program is reduced by $504 million.
Funding is eliminated for the Renewable Energy Program for fiscal year 2007.
Value-added marketing funds are eliminated for fiscal year 2007.
Funding for the research program, Initiative for Future Agriculture and Food Systems, is cancelled for fiscal years 2007-2009.
The food stamp program is cut by $844 million.
The cuts in the food stamp program are receiving a great deal of attention because the Senate made no cuts in the program, while the U.S. Department of Agriculture (USDA) recently released a report on hunger. USDA's report shows that the number of hungry people in the United States increased by 2 million in 2004. This is the fifth year in a row that the hunger number has increased. The Senate Agriculture Committee did not propose any cuts in the food stamp program. During the debate, the Democrats on the House Agriculture Committee continued to state that the proposed budget, even with the cuts in agriculture and other governmental programs, would still increase the national debt by $20 billion. This is due to the administration's proposed $70 billion in tax cuts. The House of Representatives will consider budget reconciliation next week.
Australia Pork Case -- On Nov.18, the Australian High Court will hear Australia Pork Limited's (APL) request to expedite its appeal of a ruling that lifted a ban on pork imports. APL is requesting a hearing for the high court to overturn an earlier ruling that allowed pig meat imports from countries including the United States.
Avian Influenza -- The administration announced funding of a $7.1 billion program, National Strategy to Safeguard Against the Danger of Pandemic Influenza. As part of this effort, USDA will request $91 million for additional resources to "safeguard the United States against highly transmissible forms of avian influenza." The additional funds will be used to stockpile animal vaccine, surveillance and diagnostic measures of wildlife/bird flyways, biosecurity measures, trade compliance smuggling interventions enforcement, research and development and planning and preparedness training.
Canadian Cattle Over 30 Months -- Nine congressmen are asking USDA to expedite a rule to permit the importation of cattle over 30 months of age for slaughter and meat from Canadian cattle. The members indicated the continued border closure for this type of cattle is having a negative impact on U.S. plants. The letter said, the "border closure has led some beef processing plants to significantly reduce hours or close indefinitely to absorb the increasing pressure of the current situation, resulting in job loss, reductions in workers' take home pay and plant closures." Those signing the letter were Congressmen John Boehner (R-OH); Mike Conaway (R-TX); Charles Dent (R-PA); Charles Gonzalez (D-TX); Mark Green (R-WI); Gil Gutknecht (R-MN); John Peterson (R-PA); Paul Ryan (R-WI); and Don Sherwood (R-PA).
National Soybean Rust Risk Management Tool -- USDA will continue to fund programs to track the spread of soybean rust and create the Pest Information Platform. Agriculture Secretary Mike Johanns said, "The soybean rust sentinel plots, mobile team monitoring program and online reporting system are important tools for our producers. Timely information is essential to help farmers combat plant diseases and we are committed to providing it." The soybean rust risk management tool is available at: www.sbrusa.net.