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.

In today’s fast-paced world where everyone is connected to the 24-hour news cycle, it can be difficult to tune out noise and opinions. The constant influx of COVID-19 headlines, weather maps for crop production regions, estimates of yield potential, and animal health issues have dominated agricultural news outlets. While it is natural to focus on how each of these factors could impact lean hog, corn, and soybean meal prices, it is also important to put those factors into greater context. Using futures markets to project forward margin curves for hog producers, the market is offering favorable pricing opportunities throughout the rest of the year and the first half of 2022. These margins are offered despite a tremendous amount of uncertainty heading into the same timeframe.

Leaning on lessons learned when favorable margin opportunities eroded after the initial reaction to PED and ASF, solid margin opportunities are not static and can be fleeting. For that reason, it often makes sense to begin thinking about layering into coverage when profitability can be secured, as it can be today. Despite the rapid rise in corn and soybean meal prices since the beginning of the year and the quicker-than-expected rebound in Chinese pork production, open market margins in Q4 2021 are at their highest level for this point in the year since 2014. Notwithstanding the unknowns in the marketplace, some of which are outlined below, securing historically strong profit opportunities may be an attractive option for producers today and should be considered.

No Shortage of Unknowns

As we head into the end of summer, market participants’ focus continues to zero in on new crop corn and soybean supplies. While volatility in the corn and soybean markets has tapered in recent weeks, crop condition ratings remain toward the lower end of the historical range because of widespread hot and dry weather throughout the upper Midwest. Even though we are already in August, industry opinions on final yield projections still vary greatly, placing additional emphasis on the upcoming August 12th WASDE report. In light of the continued importance of domestic weather and recent global production challenges, market volatility seems likely to persist. Uncertainties within feed markets can be managed in conjunction lean hogs to protect solid margin opportunities.

Figure 1. Corn Crop Progress

Figure 2. Soybean Crop Progress

Robust domestic demand and strong export shipments throughout the first half of this year have continued to support hog prices. Lower production, strong grocery sales, and lower weights have underpinned a hog market that made a remarkable rebound from the lows seen in the first half of 2020. While high feed prices will likely curtail expansion in the near term, there are also some uncertainties which could derail an otherwise optimistic outlook. Global swine health is always an important variable in margin outlooks and has dominated headlines in recent weeks. A common theme at recent industry events has been the impact PRRS continues to have on the domestic hog herd. On July 19, Germany confirmed its first case of African swine fever (ASF) in a domestic swine herd after more than 1,200 cases in wild boars in the eastern region of the country. On July 28, the USDA confirmed ASF in samples from pigs in the Dominican Republic, marking the first detection of the disease in the Western Hemisphere in about 40 years offering another reminder that ASF continues its march around the globe and the pork industry remains a single event away from a market-altering headline.

China was a major driver of pork export growth over the last two years but shipments and sales of pork exports to China have slowed in recent weeks. Widespread floods across China’s Henan province present another hurdle in its herd rebuilding efforts. After the province’s worst flash floods in centuries, reports of widespread crop and infrastructure losses were prevalent. More than a million livestock are reported to have died across nearly 1,700 farms, causing concern about the potential for disease to spread. Henan was the country’s second largest grain producer and the third largest pig producer in 2020.

Figure 3. Pork Export Commitments to China

Supply chain issues throughout the economy have been well-documented since the beginning of the pandemic and the hog sector has not been immune. The recent federal court ruling to repeal the provision of the New Swine Slaughter Inspection System (NSIS) that enabled pork processors to safely increase maximum line speeds adds to the uncertainty for this coming fall and winter. Combined with questions surrounding California’s Proposition 12 and its potential impact on demand as well as the recent resurgence of COVID, there are many factors that could impact future margins – both good and bad. When you consider that August 2020 hog futures traded as low as $47 and August 2021 futures traded as high as $120, protecting strong margins seems to be a prudent idea.

Current Opportunities and Structuring Your Coverage

Open market margins for Q4 2021 are at the 87th percentile of profitability over the past 10 years, offering producers a chance to protect historically strong profitability. Likewise, open market margin levels in Q1 and Q2 2022 are at the 83rd and 74th percentiles, respectively. Projected Q4 2021 margins for a demonstration operation can be seen below.

Figure 4. Q4 Open Market Margin

There are many different strategies that one may consider to protect the opportunities the market is offering today. Each strategy differs in its level of margin protection to the downside, opportunity to the upside, and cash flow considerations. A producers’ position should also reflect his or her individual bias. Given the risk and uncertainty on both the input and revenue side of the margin equation, it likely makes sense to protect both components in some way, shape, or form. Futures, options, and the recently-revamped Livestock Risk Protection (LRP) program may by viable tools to fit into your margin management approach.

Protecting favorable margin levels does not necessarily mean one must “lock in” each component with futures. For example, if a farmer is bullish on hogs, a flexible strategy could be developed to allow for an improvement in lean hog futures between today and the Q4 2021. Allowing for $10 of upside would increase the open market margin to the 95th percentile. Likewise, a producer may be bearish corn and believe there is a chance December corn futures could be trading down at $5.00 per bushel by the end of the year. Allowing for 50 cents to the downside from today’s price level would increase the open market margin to the 90th percentile of historical profitability.

With all the risks inherent in the management of forward hog margins, it is important to remain disciplined. With positive margins that are historically strong, it may make sense to examine a mix of futures, options, physical, and/or LRP to protect these margin levels. Opportunities and risks abound heading into the end of the year, from crop size to unknown exports and domestic demand. Whether focusing on margins through Q4 2021 or beginning to scale into coverage throughout the first half of 2022, a variety of different strategies can address the tradeoff between trying to preserve forward opportunity and protect existing profitability. 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 2021. All rights reserved.

The CARES Act was passed by Congress to provide quick and direct economic assistance to Americas to combat the economic impacts of COVID-19. The Act also directed the USDA to administer the newly-created Coronavirus Food Assistance Program (CFAP). CFAP has two components. The first is the Farmers for Families Food Box program, which uses $3 billion to prepare and deliver emergency food boxes to food pantries across the country. The second component of CFAP is direct payments to agricultural producers. While much has been written about the direct payments to eligible producers, there remains a degree of confusion regarding payment rates and calculations.

Beginning May 26, USDA’s Farm Service Agency will be accepting applications from agricultural producers who have suffered marketing losses due to COVID-19. The program, announced May 19, provides assistance to producers of eligible commodities that have suffered a five percent (or greater) price decline as a result of the pandemic. The direct payments program requires one application and results in a single benefit, but the funding and legislative authority derives from two separate programs. The dual sources of funding have caused some confusion among stakeholders but are further outlined below. This allows for a larger level of payment to be delivered than either single program could provide. USDA estimates the first source of funding, the CARES Act, will account for about $9.5 billion in CFAP payments. The other source of funding, the Commodity Credit Corporation, will account for an additional $6.5 billion in payments. The CCC is a business entity with the USDA and was created under the New Deal, providing the Secretary of Agriculture with broad and discretionary authority for various purposes, including direct payments. Calculations for covered commodity categories are included below.

USDA will make an initial payment of 80% of the eligible 2020 CFAP participant’s calculated 2020 CFAP payment. This allows for checks to be delivered to farmers quickly and allows for USDA to evaluate how well the program is performing compared to expectations. There is a possibility the final 20% could be subject to pro-rationing, depending how close to expectations initial payments end up.

Farm Service Agency staff at local USDA Service Centers will work with producers to file applications. CFAP payments are subject to payment limitations per person or legal entity of $250,000. This cap is on total CFAP payments for all eligible commodities. Direct payment limits also apply to LLCs, corporations, and limited partnerships. These entities may receive up to $750,000 based on the number of shareholders (not to exceed three shareholders) who contribute at least 400 hours of active person management or personal active labor. To be eligible for payments, the person or legal entity must have an adjusted gross income of less than $900,000 for tax years 2016, 2017, and 2018 or demonstrate that 75 percent of their adjusted gross income comes from farming, ranching, or forestry.

Livestock

Cattle, hogs, and sheep are included in the CFAP direct payment program. The components of the livestock CFAP payment are as follow:

  • CARES Act funding is used to compensate producers for price losses on sales of eligible livestock from January 15 through April 15
  • CCC funds are used to compensate producers for the highest inventory of eligible livestock between April 16 and May 14

For example, consider a cattle feedlot with sales of 800 fed cattle from January 15 through April 15 and a maximum inventory of 400 head from April 16 through May 14. The producer’s CFAP payment would be calculated as follows:

((800 x $214) + (400 x $33)) x 80% = $147,520

Consider a hog farmer with 7,200 head in sales of finished animals from January 15 through April 15 and a maximum inventory of 4,800 head­­­ from April 16 through May 14. The producer’s CFAP payment would be calculated as:

((7,200 x $18) + (4,800 x $17)) x 80% = $168,960

Dairy

Milk production is also included in the CFAP direct payment program. The components of the dairy payment are as follow:

  • CARES Act funding is used to compensate producers for price losses during the first quarter of 2020. This value is equal to $4.71 per hundredweight multiplied by actual milk production in the first quarter.
  • CCC funds are used to compensate producers for marketing channel disruptions for the second quarter of 2020. This value is based on a national adjustment to each producer’s production in the first quarter multiplied by $1.47 per hundredweight.

In other words, the first component compensates for value lost on actual first quarter production and the second component compensates for value lost on a calculation of second quarter production. The second quarter production is calculated by multiplying the first quarter production by 1.014 (to account for increased production in the second quarter). It is expected milk production will be established in the same manner as was used for Dairy Margin Coverage. Generally, this includes cooperative- or processor-verified documentation for marketings of milk and includes dumped milk that was pooled under a federal marketing order.

Milk production is also included in the CFAP direct payment program. The components of the dairy payment are as follow:

For example, for a dairy farmer with 400 cows and 2,440,000 pounds of milk production in Q1 2020, his CFP calculation would be the following:

((24,400 x $4.71) + (24,400 x 1.014 x $1.47)) x 80% = $121,035

Non-Specialty Crops

CFAP direct payments are also available for eligible producers of non-specialty crops that have suffered significant price decline due to the pandemic. The source of the non-specialty crop direct payments also comes from two sources—CARE Act funding and the CCC program. Payment rates for each commodity are included below.

A direct payment will be made based on 50 percent of a producer’s 2019 production or the 2019 inventory as of January 15, whichever is smaller. The smaller value is multiplied by 50 percent and then multiplied by the commodity’s applicable payment rates.

For example, consider a corn farmer who had production of 800,000 bushels in 2019 and on January 15 had 500,000 bushels in inventory. The first step in calculating the CFAP payment is to determine the smallest value between 50 percent of 2019 production (50% x 800,000 = 400,000 bushels) or January 15 inventory of 500,000 bushels. Because 50 percent of 2019 production is smaller, 400,000 bushels is used for the first variable. The rest of the calculation can be found below:

400,000 bushels x 50% x ($0.32 + $0.35) x 80% = $107,200

If the same farmer instead had only 250,000 bushels in inventory on January 15, the calculation would change. Because 200,000 bushels is less than 50 percent of the 2019 production (50% x 800,000 = 400,000 bushels), the inventory value would be the first variable in the calculation:

250,000 bushels x 50% x ($0.32 + $0.35) x 80% = $67,000

The USDA’s Farm Service Agency is the entity charged with interpreting and carrying out the final rule. The aforementioned information is an attempt to bring clarity to the program based upon our reading and interpretation. Additional information on the program can be found at https://www.farmers.gov/cfap.

What is the best way to determine the fair market value of a pig? This seemingly innocuous question has resulted in a multitude of opinions over the years as market dynamics, participants, and trends change. As the volume in the negotiated market has dwindled, some market participants have noted the rise in the use of cutout-based contracts to price hogs. But given the large amount of information published by USDA on a daily basis, how is the carcass cutout calculated and what can be gleaned from the various cutout reports?

Wholesale pork reporting as part of the USDA’s Livestock Mandatory Reporting Program (LMR, or oftentimes referred to as MPR) began in 2013 at the request of industry participants. USDA AMS publishes four daily and eight weekly pork reports from their Des Moines office by analyzing 8,000-10,000 records per day. These reports cover approximately 87% of total pork sales. All packers slaughtering more than 100,000 head of barrows and gilts (or more than 200,000 head of sows and/or boars) annually are required to report the prices and quantities of all wholesale pork sold prior to the established reporting times to USDA twice daily.

The pork carcass cutout value is a calculation of the approximate value of a carcass based on the prices received for its respective components. The USDA’s pork carcass cutout value is the estimated value of a standardized 55-56 percent lean, 215-pound carcass based upon industry-average cut yields and average market prices of sub-primal pork cuts. In other words, weighted average prices of individual items are used to calculate a weighted average value for primal cuts. The primal cut values are then used to calculate a carcass equivalent value. USDA surveys packers in July and updates the cut yields the following January if necessary. The current yields can be found below. The loin primal constitutes the largest share of the cutout value, followed by the ham, and so on.

While it is important to understand what is included in the cutout calculation, it is also vital to understand what is not. Not included in LMR reports are carcasses, some variety meats (including ears, hearts, blood meal, cheek meat, and heads), some processed items (including bacon, sausage, ground pork), case ready items, and intracompany sales.

The National Weekly Comprehensive Pork Report (LM_PK680) includes the comprehensive value and volumes of all reported wholesale pork trade with the exception of specialty pork product and is a great resource, but unfortunately did not begin until May 23, 2019. Its use for looking at long term trends is therefore limited but is an important report moving forward. One last note—FOB plant prices are as reported by the packers at their dock before transportation costs have been added. USDA also publishes FOB Omaha prices series, which are an antiquated data set that include a freight adjustment based on the distance from the reporting plant to Omaha, Nebraska. Most market participants utilize FOB plant for formulas and analyses today, of which USDA AMS publishes four national weekly pork reports:

  • Negotiated Sales (LM_PK610): price determined by seller-buyer interaction and agreement, scheduled for delivery not later than 14 days for boxed product and 10 days for combo products after the date of agreement.
  • Formula Sales (LM_PK620): price is established in reference to publicly available quoted prices.
  • Forward Sales (LM_PK630): agreement for sale of pork beyond the timeframe for a negotiated sale.
  • Export Sales (LM_PK640): as its name implies, contains sales to export markets. Unlike the other three, however, this report does not include sales to Canada or Mexico.

Each load reported in the cutout reports represents 40,000 pounds. Formula pork sales reported on the LM_PK620 report represented about 53.2% of all reported pork wholesale volume in 2019, followed by negotiated sales (25.3%), export sales (11.4%), and forward sales (10.0%).

As exports play an ever-increasing role in price discovery, an often-overlooked source of information is included in the LM_PK640 report. This data has the potential to provide an indication of export demand developments well ahead of the official figures from the U.S. Census Bureau. A single data point does not make a trend, but it is interesting to note that during the first week of the Phase One trade deal with China, the weekly volume reported on the LM_PK640 report was the 5th highest since the beginning of 2014. This data is released on Monday mornings for the week preceding, as opposed to the FAS Weekly Export Sales reports which are released on Thursdays for the week ending the preceding Thursday and official export figures which are lagged by at least five weeks.

Because a spike in volume on the LM_PK640 report could indicate robust demand, forward domestic volume as measured by the LM_PK630 Forward Sales report can, and oftentimes is, also impacted. For example, amidst robust export pork sales beginning in late September and lasting through mid-November, a perceived forward market shortage sentiment developed among participants. As a result, forward wholesale pork sales volume also posted all-time highs for the data series.

This competition for securing physical led to a counter-seasonal rise in the cutout during a period of record-breaking hog slaughter, as can be viewed below. The first chart demonstrates how the cutout typically declines from a time period beginning in the summer months into the holiday season. In 2019, however, the negotiated cutout value increased by more than 27% from September through mid-November.

The pork carcass cutout calculations produced by USDA AMS provide utility to market participants and offer context to marketplace fundamentals. Utilizing these reports may reveal perceived strength or weakness in cutout sales and provide glimpses of market conditions ahead of other more frequently leveraged data sources. As producers continue to search for the best method to determine a fair market value for their animals, it is important to understand the difference between the various cutout reports, what is included in their calculations, and what is omitted. These reports are another essential tool to employ to obtain greater clarity in an ever-dynamic, evolving marketplace, gather clues into forward demand, and potentially leverage to take control of your bottom line.

Past performance is not indicative of future results.