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Issue # 614

December 10, 2008

MMP: A Bitter Pill To Swallow - Nevil Speer, PhD, MBA, Western Kentucky University (reprinted with permission from CattleNetwork.com on 12/9/08)

The economic downturn is taking no prisoners. That's especially true for the commodity sector which finds itself under intense pressure across all fronts. This past summer there was concern about $200 oil; within the span of five months (from the $145.29 high established July 3) there's now talk of $30 (and even $20) oil. Meanwhile, we've also witnessed corn futures close below $3 for the first time since October, 2006. Most important to MMP (Monthly Market Profile) readers, fed cattle contracts have flirted with $80. Over-reaction to the downside? Most likely . . . but where it all settles out depends largely on the broader economic front. At this juncture making sense of the daily soup is nearly impossible but that doesn't negate the reality of some tough slugging in the weeks and months ahead. That'll dictate some important business implications along the way.

Most indicative of bearish sentiment and negative volatility was fed trade action in mid-November. The market was poised to move lower but cattle feeders completely capitulated and settled for a $6 setback back to $87 - a HUGE chunk to give up in one week. Fundamentals certainly didn't support that large of a move. Any sizeable entity that pulls the trigger first often sets the pace for the week; it's likely there was some response to pending liquidity demands from external influences coupled with concerns about longer-term trends. Regardless of source and/or fundamental justification of the commodity market meltdown, it's where we are right now.

Economic indicators normally provide a lagging snapshot of general activity. Individually each one is of little value; however, in the aggregate they provide a good overview of what's occurring in the broader economy. And currently, there's little indication of any major reprieve on the horizon. December ushered in a series of bad reports: first, despite a better-than-expected "Black Friday", preliminary November retail sales appear to have fallen - the fifth consecutive month; second, unemployment climbed to its highest levels in 15 years. Meanwhile, the Mortgage Bankers Association reported that 10% of all mortgages are now delinquent (versus approximately 7% a year ago); the segregated delinquency rate being 5.9% and a whopping 33% among prime and sub-prime loans, respectively.

Deleveraging and diminished liquidity is pressuring all sectors of the economy but the primary importance of those indicators being this recession is shaping up to be largely focused within the consumer sector. November's Consumer Sentiment neared an all-time low (previously established in 1980). The University of Michigan reported that, "Few consumers expect the recession to end anytime soon as just 14% of all consumers in November expected the return of good times financially in the economy during the year ahead." The trough may prove to be especially difficult and enduring as consumers retrench while undergoing fundamental transformation relative to their purchasing habits.

Food expenditures are, and will continue to be, at the forefront of people's minds. Going forward the beef complex will likely be subject to less revenue - from both a volume and value perspective: 1) reduced restaurant and food-service traffic due to cutbacks in travel (both professionally and personally) and slower leisure dining traffic (reduced volume); 2) general trading down when making dining and retail purchases (reduced value: the trading down phenomenon is illustrated by McDonald's November same-store U.S. sales which increased 4.5% with the company citing ". . . the strength of McDonald's market-leading breakfast business, the popularity of the chicken line-up as well as everyday value throughout the menu."). Adding insult to injury, beef's export prospects have been hampered by the global economic slowdown and the dollar's recent valuation appreciation.

The direct impact will occur primarily at the wholesale level. Cutout values were solidly trading mid-$150 during the run-up to Thanksgiving. However, that support level was crushed as soon as pre-holiday purchasing was completed: the Choice cutout closed the first week of December $13 lower than the pre-Thanksgiving closing value ($156). Additionally, beef throughput during October and November ran 3-4% behind last year's pace. That negative influence is being priced into both the spot fed market and CME's future contracts. It's been 28 months since fed cattle traded below $80 (July, 2006); during that time the spot market average has been nearly $92. Trade below $80 in the coming months would represent breaking through important and well sustained support levels. Similarly, feeder cattle have broken through well-established support and will continue to come under pressure, despite lower corn prices, given the CME's current bearish attitude and increasingly negative closeouts at the feedyard level.

Decline in the commodity markets has initiated some overarching concern about deflation - a perilous concept. Certainly, over the short-run that's occurring due to global economic slowdown and tightened credit liquidity. The more important question is whether wide-scale stimulus efforts can give a boost to the economy and hold off deflationary pressures. The trend of late has muted some earlier concerns about the influence of index funds. However, the fundamental opposition related to their participation remains in place and merits continued discussion (and will likely be renewed amidst any significant reversal).

The Monthly Market Profile, over the course of the past several months, has provided some perspective regarding controversy surrounding index funds and their investment within the commodity markets. There's a sizeable faction which perceives index funds as the primary factor in driving commodity prices to unsubstantiated levels; that is, cumulative investment and persistent long positions artificially drive prices higher. Simultaneously, concern is equally prevalent on the other side of the equation: index fund investments have accelerated price moves to the downside when funds began to divest their respective positions. The latter point is where we pick up this month: amplified volatility and the subsequent impact upon hedging opportunities.

It's important to note that commodity volatility is driving various companies to do more hedging as noted in the following excerpt (Hedging Now Second Nature for Food Groups, Financial Times, August 18, 2008): "Good commodity risk management is consequently becoming an essential part of remaining profitable . . . Although food companies have long employed 'procurement' people with logistical skills in sourcing commodities, they are now looking for people with experience in trading commodities…Meanwhile, consumer industry bankers say investment banks are putting money in commodities teams that give food and consumer goods companies advice on how to hedge their risk exposure. When corn prices rose or fell 5 cents per bushel per day, companies could afford not to be hedged because the price movements were not big enough to lower profits. But now that they are swinging by 30-40 cents a day, and prices have soared - which means they account for a bigger proportion of total sales - companies are being hit with considerably higher additional costs." That fuels the sentiment of some who argue this becomes a self-perpetuating problem: first the index funds invest driving prices higher and creating volatility, subsequently large food companies and corporate banks assume significant positions which inherently drives index fund interest even further. Where does that leave the individual producer?

Most notably, the size of index fund investment troubles some market observers and potentially represents disproportionate influence upon smaller investment interests within the market. That's best expressed by the following excerpt I read several months ago: "Can you imagine the leverage these funds have? What if collectively they decided to just hang on to their long positions and threaten to 'squeeze the shorts' by demanding delivery against their long positions? Or just half their long positions? The grain isn't there to deliver! Those who are short (includ-ing farmers who had 'hedged') would have no choice but to deliver the grain or bid and bid and bid . . . limit-up . . . limit-up . . . limit-up --- until the longs decided to 'have mercy' and take their profits by selling out." That sentiment summarizes well the overriding concern about the potential impact of index funds.

This is an especially interesting anecdote as it relates directly to agriculture. The author is correct, the producer who is short in an effort to hedge his/her crop would have two options: 1. attempt to offset his/her position (in a rapidly escalating market) in the futures market, or 2. make delivery according to the specifications of the contract. Fair enough. But the question remains, are either of those options necessarily a bad thing? After all, those are potential outcomes every time an entity secures a short position. What's more, it's important to remember the trader of interest is hedging - the short position represents price protection against a falling market.

Granted, the producer may lose money in the futures market to offset a position (the producer opts not to deliver). However, that loss will be made up by a rising cash market (the other side of the equation not explained in the anecdote above). Therefore, in the end, the primary objective of receiving price protection would have been facilitated as designed. That's the beauty of the system. No harm - no foul.

During the past several months commodity markets have taken a dramatic plunge. Many index fund detractors have hushed their criticism. If history serves as a guide, that's likely to be temporary as this controversy will not be settled anytime soon.

EDITOR's NOTE: Nevil Speer, author of the previous article, will be a featured presenter during session 3 of the February series, Managing Dynamic Change in the Beef Cattle Industry. Find details, and registration information in the November 12, issue #610, of the Ohio BEEF Cattle letter.

We're On Trial with a Jury of Our "Peers"? - Dr. Roy Burris, Beef Extension Specialist, University of Kentucky

The passage of Proposition 2 in California has served notice to animal agriculture that we are on trial . . . just not with a jury of our peers. You see, agriculture is a distinct minority now and urban voters can enact laws which impact our lives with little understanding of agricultural production.

So what about Prop 2 which outlawed confining cages for egg-laying hens and restrictive pens for veal calves and pregnant sows? It wasn't about beef cattle and it was in California. The president of the Humane Society of the United States said that "all animals deserve humane treatment, including animals raised for food". So, why would that make us nervous?

Well, for one thing, it comes on the heels of the ban on horse slaughter which was well-intended by folks who have visions of mustangs running wild out west. That's great but the vision of horses that now aren't being cared for isn't as good. Maybe we can just turn them loose. Where? What happens when wild animals overpopulate their areas? I'll give you a clue - today is the first morning of deer season in Kentucky and deer are all over the highways, too. What happens when you can't afford to feed animals and no market exists?

Concern for the well-being of animals is noble and universal. A well-orchestrated attempt to shut down farming isn't. So what should we, as cattle producers, do? I am reminded of what Dr. David Roselle, former president of the University of Kentucky, said when the basketball program was being investigated. The first reaction was to "circle the wagons" but he said "we will defend that which is defensible". Not a bad answer. We, ourselves, must come up with our own standards for animal care and production, and we must assure our well-fed friends that we care about animals, too. However, actual cases of cruelty or poor care must be eliminated from our production system, by us.

Beef cattle producers don't do caged-type production but I remember as a young 4-H'er when my sow had a nice litter of pigs (I needed the money for school) then laid down and mashed all of them. Boy, how I wished for a farrowing crate. I have watched sows give birth outside after making a nice "bed" only to be dismayed when they would turn around and eat the pigs. Another mortgage payment gone. But, people that have never been on a farm can't begin to understand that.

We can buy food from other countries, of course. Those countries may not have as many environmental restrictions, FDA guidelines or anything like a USDA inspection service. Food safety and wholesomeness must be assured. Who does that best? We do.

There is an old acronym that also applies - NIMBY (not in my backyard). Why don't we (as some have suggested) just depend on other countries for production agriculture? We could import food and fuel and export technology. We do need to be part of a global economy. I don't think that we should trust other countries to feed us. Talk about dependence. Food is the ultimate political football.

The Southeastern cattle industry is mainly a pastoral business with feeder calves as our product. This shouldn't be much of a problem for us but . . . what would happen if we didn't have a market for our product?

So what do we in the cattle business need to do? In my opinion, we treat our animals humanely, assure the public that we do it better than anyone else and support our organizations that defend us. We need to be organized - they are.

During this holiday season, we should resolve to "police" and protect our industry. Otherwise; folks with a bellyful of safe, wholesome food (maybe even tofu turkey) and no understanding of or appreciation for production agriculture will make laws that have a profound effect on our livelihood.

Black Vulture Control, Part One: Procedures to report a loss due to Black Vultures - Jeff Pelc, Wildlife Biologist USDA/APHIS, Wildlife Services, Tim Fine, Extension Program Assistant, Miami County

Black Vultures have become a serious beef cattle and sheep pest in certain areas of Ohio. This article will focus on the procedures necessary to report a loss due to predation by them. In the next Ohio BEEF Cattle letter, we will take a look at options for black vulture control.

There are certain procedural steps that must be followed when dealing with losses doe to Black Vulture predation. In most cases, if these procedures are not followed, compensation for your losses may not be granted.

1. Notify your local dog warden by telephone within 72 hours after the loss or injury has been discovered. The dog warden will need to come to your farm at some point and determine whether the kill was by a predator or not. If the dog warden determines that the kill was not by a predator then no further steps need to be taken.

2. Document, by photograph, the injuries sustained by the animal. This should be done directly after contacting the dog warden. Do not wait for the determination as to whether the kill was by a predator or not.

3. Obtain an indemnification form from the dog warden. This form will need to be filled out and sent to the Ohio Department of Agriculture (ODA) within 30 days of discovery of the animal. Photos taken of the injuries, and any other pertinent facts shall accompany this document. You may request assistance from the dog warden in filling out the indemnification form. If the animal injured or killed is a registered animal, then registration papers should also accompany the indemnification form.

4. If the dog warden determines that the kill was by a predator then he/she must contact by telephone the county's wildlife officer.

5. Following the notification from the dog warden, the wildlife officer must confirm, disaffirm, or state that he/she is uncertain about the determination of the dog warden on the claim. If the wildlife officer disaffirms the claim of the dog warden, the claim is dropped.

6. If the wildlife officer affirms or states that he/she is uncertain about the determination of the dog warden, the wildlife officer must notify the ODA, in writing, of his/her determination.

7. The ODA will hear claims that are approved by the dog warden and supported by the wildlife officer. The ODA may decide to grant full compensation, partial compensation, or no compensation.

8. If the owner feels that the ODA's determination of the fair market value, he/she may appeal the determination.

For more information on the indemnity process, contact the Ohio Department of Agriculture at 614-728-6220 or at http://www.ohioagriculture.gov/animal, or contact USDA/APHIS at 614-861-8607 or on the web at http://www.aphis.usda.gov/wildlife_damage/.

Weekly Roberts Agricultural Commodity Market Report - Mike Roberts, Commodity Marketing Agent, Virginia Tech

LIVE CATTLE futures on the Chicago Mercantile Exchange (CME) were up on Monday on short covering encouraged by a higher stock market. Traders also said a weaker U.S. dollar was helpful in that it should help exports. The DEC'08LC contract closed at $83.100/cwt; up $1.550/cwt but $2.35/cwt lower than a week ago. FEB'09LC futures closed up $1.225/cwt at $82.675/cwt but 3.05/cwt lower than last Monday. Last week a weaker cash cattle market, negative economic news, and fund liquidation on technical selling and oversold conditions sank prices. USDA on Monday put the Choice Beef Cutout at $143.97/cwt; up $0.82/cwt. Cash cattle on Monday were weaker as USDA put the 5-area price at $86.24/cwt; $3.58/cwt lower than last Monday. Packers are seen as cutting back on their processing pace due to large negative profit margins. According to HedgersEdge.com, the average packer margin was lowered $65.20/head from last week to a negative $74.95/head based on the average buy of $88.04/cwt vs. the average breakeven of $82.14/cwt. Hopefully short-term feed needs were priced last week as nearby corn lost ground to below $3.00/bu. Corn markets will most likely uptick again on any good financial news.

FEEDER CATTLE at the CME followed live cattle and the other commodity markets up on Monday. JAN'09FC futures finished at $87.900/cwt, up $1.25/cwt from Friday but $1.725/cwt lower than last Monday. The MAR'09FC contract settled at $86.925/cwt; up $1.65/cwt but $2.925/cwt lower than this time last week. The rebound came after the market reached its lowest point in 4 ½ years last Friday. The CME Feeder Cattle Index for December 4 was placed at $91.17/cwt; off $0.70/cwt and the lowest since March 30, 2004. Hopefully short-term feed needs were bought last week.

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