As we work through the dog days of summer, there seems to be no shortage of optimism among many hog market participants. Much of this exuberance is rational given strong domestic demand, lower sow inventories across the U.S., EU, and China, and the expectation of stronger pork exports in the last half of the year. Cash hog prices have been advancing throughout the summer while corn and soybean complex prices have perhaps found seasonal bottoms over the past couple weeks. While these factors support hog margins, we know market dynamics can, and often do, change quickly. It is natural to focus on the bullish narrative of the market, but discipline should be exercised as we begin looking at establishing margin coverage at historically strong profitability in deferred periods.

Hog Market Considerations

The bullish case for hogs is compelling but continued headwinds on the trade front could complicate matters. Compared to last year, USDA projects U.S. pork production to fall 1.9 percent in 2022 while they peg 2023 production to increase only 1.3 percent year-over-year. Domestically, retail pork prices continue to set new record highs but remain near their long-term average as a share of retail beef prices. Of course, for a sector that exports a quarter of its production, no story on pork demand can be complete without looking at international trade. USDA projects 2022 pork exports to fall 6.4 percent from 2021. Through May (the most recent month for which complete data is available), pork exports were down 20 percent from a year earlier. Of the major trading partners, only Mexico has posted year-to-date gains from 2021.

Figure 1. U.S. Pork Exports

China’s reduction in imports from all sources has weighed on global pork trade in general and the strength of the U.S. dollar is making American product more expensive for foreign consumers. China’s slowing economy, coupled with the prospect of a recession on the horizon, could reduce international demand. USDA forecasts 2023 per capita pork consumption to be 52.4 pounds per capita. If realized, this would tie the highest level witnessed since 2000, but it is important to remember any disruption in or destruction of export demand will only exacerbate the onus put on the domestic consumer next year.

Figure 2. China Pork Exports

If the last several years have taught us anything, it is that things can change in a hurry. The CME lean hog index has been on a steady march higher since mid-May and is approaching levels last witnessed in June 2021. The PED-impacted summer of 2014 is generally held as the gold standard of the height to which hog prices can reach, but oftentimes missing from that discussion is how short-lived that price environment ended up lasting. The market scored a low in January 2014, increased through April, pulled back into June, and ran out of steam by mid-July. While the run-up in hog prices was rapid, the retreat was swift, as well. The domestic hog herd was rebuilt as producers responded to market signals. At the same time, labor disputes at West Coast ports caused major disruptions to international trade in the second half of 2014 and early 2015. One cannot help but draw a parallel between the port slowdowns from 8 years ago and the bottlenecks in supply chains we are experiencing today.

Figure 3. Historical Daily Lean Hog Index

Feedstuff considerations

New crop futures contracts gave up Ukrainian war and weather premium over the past several weeks to return to levels last witnessed in February, offering end users a chance to protect more favorable price levels. Corn futures prices have been in reprieve since mid-June as concerns about late plantings were largely mitigated and timely rains arrived in the heart of the Corn Belt. Overall, the market fell about $2 per bushel from the mid-May high through mid-July. It is difficult to know where we go from here, but it is typical for the December contract to find a bottom in late summer. Crop condition ratings overall are slightly behind year ago levels on a national scale but remain significantly behind a year ago in the eastern Corn Belt and the High Plains.

Figure 4. Corn Conditions Map

According to CFTC data, the non-commercial long position is at a multi-year low. This all comes against the backdrop, of course, of tremendous uncertainty in the form of conflict in Ukraine, La Niña-induced dryness in South America, and expanding drought in the EU. The global corn exporter balance sheet is historically tight and there appears to be little room for yield loss this year or next, so long as product from the Black Sea cannot find its way to the world market.

Figure 5. Corn Exporter Stocks-to-Use Ratio

New crop soybean futures have followed a similar trajectory to corn. The recent pullback has uncovered demand from overseas buyers. USDA reported flash sales to China last week for the first time since June 1 and new crop soybean sales to China are at their highest level for this point in the year since 2013. Crop conditions are similar to a year ago with marked improvement across the Dakotas, but we know August weather is a vital determinant of yield potential. Weather across the central U.S. will continue to take center stage over the next few weeks. Like corn, the soybean exporter balance sheet is historically tight.

Figure 6. Soybean Exporter Stocks-to-Use

The soy complex is also in the midst of a radical change and livestock producers will likely reap the benefits. The push for renewable diesel to reduce carbon emissions has spurred a flurry of investment in crush plants across the country. The expectation is the influx of demand for soybeans and bean oil will result in increased availability of meal, driving meal costs lower. It is important to remember, however, that many of these plants are not set to come into fruition until late 2023 or 2024. While these developments could be beneficial for soybean meal buyers, it may not be fully realized for another crop year or two.

Risk Management Implications

With the geopolitics, weather, and the other market forces outlined above making headlines on a daily basis, it is easy to not see the forest for the trees. Forward profit margins on our demonstration operation have rebounded from lows scored in mid-May and are offering producers a chance to protect historically strong profitability through Q3 2023. We are near or above the 75th percentile of historical profitability over the past decade for the next 12 months.

While potential remains for margins to continue higher if the bullish fundamentals outlined above come to fruition, significant risk to the downside remains. Most producers are unwilling to completely lock in margin levels today with futures purchases and sales due to fear of missing out on higher margins. Flexible strategies can be employed to allow for margin improvement while providing protection against adverse movements in hog prices, corn and meal prices, or a combination of the three.

Figure 7. Q3 2023 Margins

Objectively assessing margin opportunities in the future is the first step to determine whether they are worth protecting. It also helps remove the constant noise in the marketplace. Discipline is at the core of every sound risk management approach. Producers have been given a chance to remove significant risk from their operations over the next year while maintaining opportunity to the upside through flexible coverage. For more help on evaluating specific strategy alternatives or to review your operation’s risk profile, please feel free to contact us.

Trading futures and options carries a risk of loss. Past performance is not indicative of future results. Insurance coverage cannot be bound or changed via phone or email. CIH is an equal opportunity employer and provider. © CIH. All rights reserved.

For many of us involved in the pork industry, the turn of the calendar to June means World Pork Expo is once again upon us. The event serves as the unofficial start to the summer season for many stakeholders and allows us all the opportunity to catch up in person with friends, colleagues, and industry professionals.

We most look forward to the conversations we will have—many of which will likely expound on topics such as domestic disease mitigation, Chinese demand, and tight global grain and oilseed balance sheets. Each of these areas are critically important and have been covered at length in trade publications over the past several years. But another topic that warrants discussion at this year’s gathering is the good work done on behalf of livestock producers by USDA’s Risk Management Agency and its Federal Crop Insurance Corporation (FCIC).

USDA has offered two livestock insurance products for swine producers for nearly two decades. Livestock Risk Protection (LRP) is an insurance product designed to protect against a decline in market price. Livestock Gross Margin for Swine (LGM) provides protection against the loss of gross margin of swine (market value of livestock minus feed costs). Several rounds of LRP and LGM modifications approved by the FCIC over the past two years have made the insurance products a valuable component to many producers’ toolbox to manage risk. These changes have broadened the appeal to producers by increasing premium subsidies, increasing head limits, extending endorsement lengths, and easing the strain on producer cash flows. As a result, participation in the insurance programs has increased substantially.

Figure 1. Participation Growth in LGM and LRP

The most recent round of LRP revisions, announced in April 2022, continued to build upon recent improvements and will likely increase participation in these important programs. One modification increased both endorsement and crop year head limits beginning in Crop Year 2023, which runs from July 1, 2022 to June 30, 2023. Previously, the limit per swine endorsement was 40,000 head, or 150,000 head per producer for each crop year. Recent modifications increase those limits to 70,000 head per endorsement and 750,000 head per crop year. This amplified the number of animals that could be protected from future market price declines, substantially bolstering the safety net for hog producers. There has never been an annual head limit on LGM-Swine.

Several of the changes announced were designed to increase options at producers’ disposal. Whereas livestock producers previously had to choose between one program or the other, they can now use both. An insured may not, however, insure the same class of livestock with the same end month or have the same insured livestock insured under multiple policies. This allows for flexibility in decision making and lets producers make the best choice for their own financial situation and their own operation. LRP policies were also changed to allow any covered livestock to be “marketable” (meet a minimum weight requirement) by an endorsement’s end date. Previously, protected swine actually needed to be marketed within 60 days prior to the end date or maintain ownership on the end date.

Recent modifications also were geared toward allowing a wider array of ownership structures to participate in the program, better reflecting the diversity of participants in the pork production sector. Past policy language stated that only producers who owned sows under the same entity that owned and marketed the finished swine were able to purchase LRP for Unborn Swine. This limited the number of producers who could protect future swine marketing beyond 6 months out in time. This policy now states that the sows do not have to be owned in the same entity name as they are marketed. Proof of ownership prior to the issuance of an indemnity is also required, bolstering the integrity of LRP.

Additional changes to the programs include reducing the time limit for insurance companies to pay indemnities from 60 days to 30 days, clarifying how head limits are tracked when an insured entity has multiple owners, providing insured producers greater choices in how they receive indemnities, and modifying the endorsement length for swine to a minimum of 30 weeks for unborn swine and a maximum of 30 weeks for all other swine. These improvements to both the LRP and LGM programs have allowed for reduced costs and increased flexibility to the producer, taking two relatively unused programs and making them widely available across the industry to producers of all sizes.

We view these insurance products as important additions to producers’ toolbox to manage margins over time. It is important to note that the decision to use LRP is not an either/or decision with exchange-traded instruments. Many producers have also found utility in pairing the LRP coverage as the root of other futures and options strategies. With tremendous uncertainty and volatility proliferating throughout the equity and commodity markets today, establishing floors via subsidized insurance programs could make a lot of sense for many farmers.

A prime example of how one could implement LRP or LGM as part of a risk management strategy is looking at open market hog margins toward the end of the year. Despite multi-year highs in corn futures and elevated soybean meal prices resulting from conflict in Eastern Europe, dryness in South America, and a slower-than-normal domestic planting pace, open market margins for the 4th quarter offer producers the chance to protect slightly better-than-average profitability. Looking at the chart below, there is a very strong seasonal tendency for both December lean hog futures as well as 4th quarter margins to fall from early June into the first week of August.

Figure 2. December Lean Hog 10-Year Seasonality

Figure 3. Q4 Open Market Hog Margin 10-Year Seasonality

While many producers may not be willing to simply lock in these margin levels with straight futures purchases and sales, some may be willing to establish protection with floors and maintain opportunity to the upside using either of the insurance products. The seasonal charts above indicate it could be timely to do so over the next several weeks. On the one hand, the latest Hogs and Pigs report indicated a continued reduction in market hog availability compared to a year ago. On the other hand, continued lackluster export demand or crop production issues could squeeze the better-than-average open market margins being offered today. LRP or LGM could be a great start in establishing coverage given current margin levels and the seasonal tendency for margins to fall over the next two months. 

The sign-up process for LRP and LGM is simple and program costs are uniform across all agencies. The value the agent brings is their expertise, tools, and analysis. Contact us or visit us at Booth V361 in the Varied Industries Building at this month’s World Pork Expo to discuss effective applications of these tools and how these programs could fit into your risk management approach.

Trading futures and options carries a risk of loss.  Past performance is not indicative of future results.  Insurance coverage cannot be bound or changed via phone or email.  CIH is an equal opportunity employer and provider.  © CIH.  All rights reserved.

The outlook for forward hog margins is less optimistic than it was even a month ago following the release of the USDA’s September Hogs & Pigs report. The surprising data indicating there were fewer pigs than what the market anticipated produced a bullish response in the futures market, although that soon faded as the calendar turned over to October. Spot December Lean Hog futures subsequently dropped about $13/cwt., and despite a recent bounce remain below the level we were trading prior to that quarterly report. Factors including a concern over labor shortages that could impact processor capacity in the winter months when it is needed the most as well as a significant slowdown in pork export sales to China recently have in part been attributed to the recent slump.

Meanwhile, feed costs have crept higher despite what generally have been better than expected yield results for both corn and soybeans as harvest winds down. Strong corn demand from the ethanol sector as margins swell to multi-year highs have supported the spot market, while concerns over South American weather and high fertilizer prices potentially reducing corn acreage in the U.S. next spring are adding premium further out on the curve. As a result of pressure from both lower hog prices and higher projected feed costs recently, forward margins have deteriorated over the past month and are only about average from a historical perspective looking back over the past 10 years. (Figure 1)

Figure 1 – Hog Margins (Q4 2021 – Q3 2022)

Focusing on either the spot Q4 or upcoming Q1 marketing periods, where margins are currently negative, there have been ample opportunities over the past several months to protect historically strong profitability and well above average margins. In fact, Q4 margins briefly breeched the 90th percentile of the past decade following the September Hogs and Pigs report, with projected profitability at $7.89/cwt. on September 30th (Figure 2). This followed a series of opportunities to protect at least 80th percentile margins going back to the middle of May. While it is obviously too late to do anything about protecting Q4 margins now that the marketing period is almost half over, there may be upcoming opportunities to address risk further out in 2022 if the margin landscape improves.

Figure 2 – Q4 2021 Hog Margin

In order to take advantage of these opportunities however, it is important to know where your margins are at. 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. Will China begin to see sow liquidation due to depressed prices and negative margins? Are there going to be less corn acres next spring because of high input costs? Is South America going to have a drought during their growing season? If strong demand continues from the ethanol sector, is it possible that the balance sheet may end up being much tighter than what the market expects?

Looking again at the graph of Q4 hog margins in Figure 2, you will notice that there has been quite a bit of volatility over the past six months. Margins have ranged from over $7.50/cwt. positive to about $5/cwt. negative since the middle of April. Swings in both hog prices and feed input costs have led to these changes in projected profitability, and this volatility creates opportunities. In addition to signaling beneficial times to initiate margin coverage, these price swings also allow for opportunities to improve existing margin protection. Examples of this include reducing cost in hedging strategies, creating more price flexibility in hedge positions, cutting exposure to performance bonds, and taking equity out of positions.

Moreover, with recent improvements to the LRP program and new alternatives like the CME’s pork cutout contract, there are now a variety of ways that margin protection can be established and more opportunities to create complimentary or supplemental positions once this protection is put in place. Regardless of the tools used, the main point is to have a plan and be disciplined with following through on that plan. Does your operation have triggers in place to establish coverage in forward time periods? Do you anticipate what types of supplemental strategies might allow you to improve on that coverage over time?

Figure 3 – Q4 Hog Margin 10-Year Seasonal

Figure 3 displays the seasonal tendency for Q4 margins over the past 10 years. The recent spike in margins to above the 90th percentile corresponds to a typical period of strength where margins seasonally peak at the 85th percentile by the first week of October. A secondary period of strength typically occurs from mid-January to mid-April (highlighted by the green bars), suggesting that producers be ready to execute on possible opportunities that may show up into that period. Similar approaches could be taken for other periods such as Q2 and Q3 2022.

Inventorying your costs and revenues to project forward margins and putting a plan together that will allow your operation to take advantage of opportunities once they arise can put your operation in a better position to be competitive. Now more than ever, it is important to be proactive in managing forward profitability. Please feel free to contact us with questions on how to create a margin management plan and take change of your bottom line.

Trading futures and options carries a risk of loss.  Past performance is not indicative of future results.  Insurance coverage cannot be bound or changed via phone or email.  CIH is an equal opportunity employer.  © CIH.  All rights reserved.