What Could Go Wrong? Maintaining Discipline Amid Market Uncertainty.

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.

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