Hog margins have steadily improved since the beginning of the year. Futures markets are projecting the highest forward-looking hog margins for a model operation since 2014. Taking Q2 as an example, current margin projections are about $25/cwt., one of the highest projections for this quarter over the previous 10 years, and the highest for this point in the calendar year since 2014 when margins peaked at about $50/cwt. during the first week of March.
The opportunity to protect historically rare margin levels comes on the heels of a red-hot hog market, despite corn and soybean complex futures notching multi-year highs. The strength in feed markets has been quite remarkable, and it is important to realize the impact this has on profitability. Since the beginning of October, the nearly $1.00/bushel rise in corn and $100/ton increase in soybean meal have combined to reduce margins by about $8/cwt. for Q2, even though projected margins have improved almost $9/cwt. overall since then. The increase in projected hog prices has more than offset the increase in feed costs.
While you may believe the opportunity to the upside for hogs outweighs the risk to the downside, it may be prudent to protect forward profitability, particularly in deferred periods where margins could end up being weaker than current projections. Q3 2022 hog margins are currently just below $20/cwt., and like Q2, are in the top decile of the previous decade at the 93rd percentile of the past 10 years. While both Q4 and Q1 2023 margins are comparatively weaker from a historical perspective, they are nonetheless above average and close to the 80th percentile of the previous decade. Moreover, we are moving into a seasonal period where it has historically been beneficial to protect winter margins as they tend to peak during the spring.
While feed costs are already quite high, a further rise in prices could pressure forward profitability during a period when it may be more difficult for hog and pork prices to keep pace. The recent Russian invasion of Ukraine adds a whole new risk dimension to the global supply/demand outlook. The slowing of Ukrainian corn flow is a major potential issue in a tightening global balance sheet situation. Tension in the Black Sea region introduced new volatility to the market over the past several weeks.
While there are a multitude of knock-on effects from the escalation, the corn market has been particularly impacted. According to the latest WASDE report, USDA projects Ukraine to account for 17 percent of global corn exports. Ukraine on February 24 suspended commercial shipping at its ports after Russian forces invaded the country. While it is unclear the impact this will have long term on the Eastern European country’s ability to supply grain to the world, futures markets were limit up in the immediate aftermath of the invasion.
Moreover, the major corn and soybean exporter stocks to use ratios are historically low, and this magnifies the risk from uncertainty in the aftermath of Ukraine’s situation. Major corn exporter stock-to-use for the 21/22 crop year of 8.4 percent in the latest WASDE is well-below the average over the past decade. It is important to note this figure accounts for record corn production in both Argentina and Brazil, where La Nina has significantly impacted crop planting and conditions. Most analysts expect the South American crop to continue shrinking, putting further pressure on an already tighter-than-average global balance sheet.
Likewise, the global soybean balance sheet is also historically tight. USDA last projected the major soybean exporter stock-to-use ratio at 16.8 percent. If realized, this would be the lowest level since 1996. Similar to corn, USDA has been shrinking South American soybean production in each of the last two WASDE reports. Crop conditions in both Brazil and Argentina continue to struggle, opening the door for a continued tightening of the global balance sheet.
The fertilizer market is another risk factor for corn which could significantly impact the domestic supply/demand balance sheet for the upcoming crop year, particularly if the weather is unfavorable during the planting and growing season. Russia is the second largest nitrogenous fertilizer exporter to the US and nitrogenous is the second most imported type of fertilizer. Corn typically requires applications of all three nutrients (Nitrogenous, Phosphatic, Potassic), while soybeans typically only need Phosphatic and Potassic. If the Russia/Ukraine conflict leads to lower supply/higher priced Nitrogenous fertilizer, there could be more incentive to either plant soybeans over corn or use less fertilizer on the corn which would decrease yields and production.
The US imports approximately 27% of the domestic nitrogen supply, with imports sourced from Canada (19%), Russia (18%), Qatar (14%), and Trinidad and Tobago (10%). Russia recently set 6-month quotas on phosphate fertilizers, further stressing the global market. Russia accounted for 10% of global processed phosphate exports in 2020. Potassium is also important for corn growth as it aids in disease resistance and water stress tolerance. The US imports the vast majority of its potash consumption annually with imports sourced from Canada (85%), Belarus (6%) and Russia (6%).
The USDA’s Outlook Forum recently estimated 2022/23 US corn ending stocks at 1.965 billion bushels, up 425 million from this year with a stocks/use ratio at 13.2% which if realized would be the highest since the 2019/20 crop year. The projected season-ending corn price received by producers was forecast down 45 cents from the current year to $5.00/bushel. Obviously, there are a lot of assumptions in this forecast including trendline yields and normal growing conditions. The good news is that despite currently high feed prices there are margin opportunities, and it may be prudent to take advantage of these opportunities including the protection of feed input costs.
To take advantage of opportunities, it is important to know where your margins are. By taking account of your various input costs and expenses and projecting hog sales revenue against those, you can begin tracking forward profitability and put that into a historical context. This will allow you to objectively determine favorable opportunities to initiate margin protection and shield your operation from either rising feed costs or declining hog prices. While no one can know for certain what the markets will do as we move forward in time, it is probably safe to say that we can expect more volatility given increased uncertainties.
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Most growers are probably reluctant sellers of new-crop corn in the current market for a variety of reasons. First, with old-crop corn trading at life-of-contract highs, whatever previous sales they had on bushels already relinquished were done at worse prices than now exist in the open market. Second, current spot prices are also at a significant premium to new-crop values, with an approximate 75-cent inverse between May and December futures. Many may feel that new-crop corn is therefore “undervalued” and does not adequately reflect what corn should be worth come harvest. Moreover, the inverse should close at some point with new-crop prices rising to meet old-crop price levels.
Over the previous 25 years, there have only been 5 others besides 2021 when this type of inverse has existed as of early April: 2013, 2012, 2011, 1997, and 1996. It is instructive to compare these “analog” years historically to determine whether selling December corn futures into a seasonal spring/summer rally has been beneficial to the grower versus staying open to the market into the harvest period.
Looking over this history that extends back to 1996, we can examine the seasonal tendency of December corn futures; or rather, at what time(s) of year generally does the contract tend to record its highest price? This history reveals that December corn futures generally peak by now, or by sometime in mid-June (Figure 1).
This suggests that savvy marketers should probably be prepared with some type of plan to scale into sales over the next several weeks. Obviously, there are risks that prices this year may behave counter-seasonally and possibly peak later in the summer or potentially not until the harvest period. There is one example in this history of analog years that is interesting where such a risk may play out in the current year.
Figure 1. December Corn Futures Seasonal Chart (1985-2020):
The analog years span a wide history, with three recent examples and two during the pre-ethanol era when corn prices were trading at much lower levels than what is the case now. Price peaks for December corn futures came as early as March 27 during 1997 (the 1996-97 crop marketing year), and as late as August 30 in 2011.
In one year, the low for December corn futures on June 15th preceded the high for the contract that year on August 21st. This was the infamous drought year of 2012 when a 60-year event across the Corn Belt shrank national corn yields to 123 bushels/acre and sent the domestic stocks/use ratio down to 7.4% vs. the 10.2% projected this year. Not only did the high come later that particular year, but harvest prices were over $7.00/bushel and considerably higher than where spring prices that year were trading in the low to mid-$5.00 range.
Figure 2 shows a table of these 5 analog years, with the inverse between May and December corn futures as of the beginning of April noted along with highs, lows, and dates of the December corn futures contract for comparison. The 2012 year is indicated with an asterisk to reflect the one year where a marketing strategy based on a seasonally scaled-in selling approach was disadvantageous to the grower by harvest time and expiration of the contract.
Figure 2. Comparison of Analog Years for the December Corn Futures Contract:
Inverted Corn Markets are Not Predictive
While most growers will naturally be reluctant to sell forward new-crop bushels this season, there are compelling reasons to consider doing so. While prospective acreage based on the USDA’s preliminary report is below market expectations and only marginally above last year, that may yet change by the final figure in late June. Moreover, a fast start to planting this season may also encourage additional corn acreage that may not have been intended.
In addition, much of the bullish fundamental outlook is predicated on the continuation of strong demand, particularly from China. Given recent news of new ASF variants taking out around 9 million sows, forward demand is questionable despite clear intentions and incentives to rebuild the herd there. Also, high prices are likely to encourage additional corn acreage outside of the U.S., and the world supply/demand balance is not as historically tight relative to the U.S.
In conclusion, there is strong historical evidence that selling into this type of market structure has been beneficial based on past analog years. Moreover, inverted markets are not predictive of future price direction. It is not true that forward prices will always rise to meet spot values. Unless there is a widespread drought this summer, it may be difficult for corn futures to push significantly higher from current levels, particularly given the degree of fund length already in the current market.
As a result, it may be the case this year that adhering to a disciplined, normal schedule of progressively scaling into new-crop corn sales over the spring and summer will prove beneficial by harvest this fall. While most growers will likely be bullish, new-crop marketing plans might be a timely thing to prepare as we move further into the spring.
For more help on initiating marketing strategies or to review your own strategies, please feel free to contact us.
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