This month we will be looking at the MRCI April 16 Lean Hogs vs April 16 Live Cattle inter-commodity spread trade. According to MRCI’s Spread Outlook report “A new cold storage season for pork begins November 1, generating a background of demand for hogs, and retail grocers will feature pork over beef for the holidays. But the market also knows that hog slaughter approaches its seasonal nadir in April whereas cattle slaughter begins to surge in March/April.”
TRADE IDEA: Buy April 2016 Lean Hogs and sell April 2016 Live Cattle on 10/26 and exit 11/20. MRCI entry and exits are based on settlement prices. Suggested risk is $1449 stop on close. Margin is $3300 per spread. Per MRCI’s Hypothetical Table below the average profit on winning trades the past 15 years was $1226 and the worst drawdown in 15 years was $2312 in 2009.
- MRCI Hypothetical P&L Table
The Hypothetical P&L Table shows this trade may have worked out 14 out of the past 15 years when entering at the close on 10/25 and exiting at the close on 11/20. Please note the 25th falls on a Sunday this year so the trade idea start date moves to Monday the 26th. In the past 14 years when the trade did work out, the Hypothetical P&L was less than $200 three times, between $600 and $900 five times, and over $1000 six times. This is one of the more price volatile spread trades you will see at MRCI (which is the case with most inter-commodity spreads). There were hypothetical drawdowns in 2012 of $1532 and in 2009 of $2312. I think this year we could see a big range in both profit and loss potential. Prices are historically very high for livestock and that means the expected range (up and down) could be higher than normal too.
- 15 Year Seasonal Trend Chart
The fifteen year seasonal trend chart below shows this year’s price spread trading relatively well with the 15 year average. I like to see that because it suggests the normal seasonal forces may be at work this year (could also be a coincidence). We would like to see this spread come in just a little bit more before the start date.
- 15 Year Monthly Spread Price Chart
The monthly chart below shows where this spread has been trading since 2001. Up until 2 years ago this spread traded between -48.00 and -8.00. In other words it means Live Cattle traded between $8 and $48 over Hogs. In the past two years the range has been -55.00 to -104.00, meaning Live Cattle was $55 to $104 over Lean Hogs.
- Final Thoughts
Two years ago many ranchers were forced to cull their cattle as they were unable to feed them via drought and lack of feed grain. It takes about two years to replace cattle and we are seeing more supply come to market. The USDA in recent reports has also commented on expanding supply in cattle and beef. Live Cattle is a market still in a very important transition.
Hogs on the other hand have been more stable this year compared to cattle. That was not the case two years ago when hogs were crushed by PEDv and high feed costs (or no feed available), but with that lethal virus behind the pig and hog industry and cheap available feed, supplies should be steady.
This spread can be volatile, and it may not be a winner during the seasonal window, but as cattle comes back to a more normal supply market (like it was before 2014), the spread between Live Cattle and Lean Hogs should eventually come back to a range between $8 and $50 like it had been trading in before the great livestock crisis of 2014. This is not just an idea we like for the seasonal window, but a theme we think will play out in the market in 2015 and into 2016.
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