Feeder Cattle Sell Off’s for Dummies

This is a sample entry from John Payne’s newsletter, This Week in Grain, published on March 20, 2013.

The liquidation of the livestock industry continues today, led by deferred feeder cattle contracts. I believe much of this is due to the sequestration of meat inspectors. Here is a short and simplified cause/effect chain for those who are new to trading cattle:

1. No meat inspectors or less meat inspectors = less/slower beef production
2. Less/slower beef production = less demand for fat cattle to turn into food
3. Less demand for fat cattle = live fat cattle remains on feed longer, slowing the supply chain
4. Slower supply chain = less demand for feeder cattle from feed lots
5. Less demand for feeders = more supply sitting around the cow/calf operation yards (these are the people who feed calves and get them to 800 lbs)
6. More supply just sitting around, combined with falling prices = industry in crisis

MAJOR EFFECT = LESS PRODUCTION OF MEAT, HIGHER PRICES DOWN THE ROAD

Right now, it’s a circle started by a sudden loss in demand of beef by packers. This doesn’t mean humans aren’t demanding more meat. This loss of demand comes from the slowing of production of beef. The cow/calf operators are the ones getting beat up the most. In the grain business, farmers can simply store grain and wait for better prices. Their risk lies with keeping the grain in good condition. In livestock, we are dealing with live animals. These are investments that have to eat. If they die, they are worth nothing close to what they are when they make it to the end of the supply chain. This leaves the cow/calf guys with two choices:

• Liquidate the herd, get rid of everything. This is not attractive because the bids from the feed lots are really low (weak basis see #4).
• Fatten the cattle themselves; cutting out the feeder market and sell on the live market once they are fat. This choice is not any easier. Feed prices are high. That said, I believe operators are making this choice. Cash corn is up 60 cents over the past two weeks. This sudden demand for grain does not fall out of the sky at this time of the year. Someone new is buying feed.

I believe we are seeing a lot of both choices. The market is being flooded with feeder cattle as operators throw in the towel. They are doing this by either moving product or selling futures. These guys are normally the toughest around; they know how to handle risk. But even this break is too much to handle for some. The crush margins are improving, but are still in the red as they have been for months. The silver lining is that the market is doing the government’s job for them. Less cattle being raised = less need for beef inspectors.

The wild card here is the fact that maybe we have too many meat inspectors already (the government wouldn’t hire a bloated staff, would they?) Maybe the administration is just selling fear. Maybe the invisible hand kicks in and the packers start to see some value. Maybe this will be seen in the cash markets as we come out of Lent. The “maybes” are starting to add up. For a market, the only thing worse than bearish fundamentals is uncertainty. This is a perfect example of that belief.

If we could get some certainty and it would result in reversing steps 1-6 above, god bless those who are sitting short this market. The bounce could be ruthless. That said, I’m not so sure the government is going to come to the rescue. I think the safest bet is the prediction that the next 6 trading days are going to be full of fireworks.

APRIL/AUGUST CRUSH SPREAD

FRONT MONTH FEEDERS (WEEKLY/ROLLED)

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