Halloween is a time of year when both kids and adults alike have fun being spooked but the hog market price action over the past month has been downright scary. December Lean Hog futures on the CME lost 18% in value over the second half of September, declining from $89 to $73/cwt. before recovering all of that lost value through October. As of this writing, the market has again turned down after facing resistance near the $90 level which has capped the contract on multiple occasions dating back to April. The feed markets by contrast have been steadier over the past couple months, although both corn and soybean meal continue to trade at historically elevated prices which has raised the cost of production and breakeven levels into 2023. From a margin standpoint, projected profitability in Q1 has seen an enormous swing with the recent hog market volatility, moving from a positive $5.00/cwt. around the 80th percentile of the past 10 years to a negative $8.50 earlier this month before recovering to back above breakeven (Figure 1).
Fundamentally, there is a lot to be optimistic about for the hog market which helps justify the recent price recovery. The September Hogs and Pigs report confirmed lower inventories including a decline in the breeding herd and forward farrowing intentions that will tighten supplies moving into next year. Moreover, producers are current as evidenced by recent trends in both slaughter weights and spot prices paid in the cash hog market. The latest Cold Storage report featured a contra-seasonal decline in pork freezer inventories, led by hams which at 159.3 million pounds were down 3% from August and 18% below last year (Figure 2).
A September drawdown in ham stocks is rare. 2019 is the only other occurrence in the past 15 years in which frozen ham inventories declined from August to September. It is interesting to note that the pork cutout contra-seasonally increased into mid-November during 2019 (Figure 3).
Turkey supplies are extremely tight this year following the Avian Influenza outbreak that hit commercial breeding flocks, and while ham prices are historically high, they remain competitive with turkey and an attractive alternative for Thanksgiving and Christmas celebrations (Figure 4). Strong export sales and shipments to Mexico are likewise supporting ham values, as the Mexican peso has not lost value to the USD despite the aggressive pace of monetary tightening by the Federal Reserve which has strengthened the dollar significantly in forex markets. Recently, exports sales have even picked up to other markets such as Japan and South Korea, two countries whose currencies have lost considerable value to the USD this year. Meanwhile, recent strength in Chinese hog prices has raised speculation that they will be more active buyers of pork on the world market ahead of the Lunar New Year, although a recent plunge in DCE hog futures prices and a significant slowdown in their economy due to the ongoing zero-Covid policy are concerning.
While overall the fundamental backdrop of the hog market is supportive as we move through Q4, one should not lose sight of the risks. The winter months historically have not been favorable for hog prices and the risk of recession here in the U.S. has risen significantly with the aggressive pace of Fed tightening. The potential impact on consumer spending should not be overlooked, and there are already indications that spending habits have changed for food consumed both at and away from home. Moreover, ASF remains a big risk factor and history has demonstrated that market reaction tends to be sharp and swift when disease issues suddenly disrupt exports.
With the recent recovery in both hog prices and forward margins, it may be prudent to look at strategies to mitigate downside risk, particularly for those who may be light on coverage in 2023. Given the potentially supportive fundamental backdrop, strategies that retain flexibility to participate in higher hog prices and improved margins may be prudent to consider. Livestock Risk Protection (LRP) insurance may be a cost-effective way to put a floor under the market while allowing for the possibility to capture any further price advances. In addition to the reduced cost and cash flow advantages with this type of coverage, there may also be basis management applications that would be advantageous for Q1.
As an alternative to LRP, option strategies may likewise make sense to retain upside price flexibility while helping to put a floor under the market and protect against negative margin outcomes. While exchange-traded alternatives may be more costly than using LRP, the expense could be reduced by accepting a cap above the market which would correspond to historically high hog prices and strong margins should the market reach that threshold. As with any strategy, it is important to strike a balance between risk and opportunity that allows your operation to manage margin volatility and achieve long-term goals. The market has provided another opportunity to help mitigate forward exposure and it may be wise to take advantage of it.
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.