Beef Wraps

Cash cattle averaged $143 this week, up almost $2 from last week’s
average. However, the national average price masks a wide disparity
between prices in the North, which were $145-147, and those in the South,
where $140-141 was more common. Cattle supplies are tighter in the north
and packers have a big book of product to deliver on as May approaches, so
they were forced into bidding up the northern market. Of course, this leaves
cattle feeders in the South feeling a little like second-class citizens, so in their
search for better pricing they turned to delivering against the futures contract.
Seven delivery certificates were tendered on Thursday and another 25 were
tendered this afternoon. This highlights an important characteristic of the live
cattle futures contract, which is settled by physical delivery of cattle at one of
16 delivery locations scattered across cattle country. When there are
significant regional differences in cash prices, deliveries will be attracted to
the delivery points where cash cattle prices are the lowest. For students of
futures markets, this is known as the “cheapest to deliver” phenomenon.

Imagine if the Apr contract was priced close to the $145 that was paid in the
North this week. Cattle feeders in the South, who can only muster $141 from
the packers, could “sell” their cattle to the CME through the delivery process
at a much higher price than they can get locally from packers. Thus, an indelivery futures contract must remain close to the prevailing price level in the
cheapest market or else it will attract deliveries. Sometimes speculators
forget this important feature of markets and bid the nearby up too much when
they see prices in one region advancing rapidly (like the North did this week).
In the case of today’s 25 delivery certificates, the tendering short didn’t have
to submit those to the clearinghouse until 3pm Central today. That means he
got the opportunity to see today’s Cattle on Feed report before making his
decision on whether or not to deliver. That probably made the decision to
deliver a lot easier. Speaking of the Cattle on Feed report, it looks like it is
going to be a big market mover. USDA pegged March placements nearly the
same as last year, but analysts were looking for an 8% decline on average.
That is a huge miss and will likely send the market plummeting on Monday
morning.

The market had already begun to look overdone after a three-day rally this
week that had added about $4 to the Jun contract before it pulled back today.
So, the bearish COF combined with 25 fresh deliveries has the making for a
deeply red day in the market on Monday. That will likely have packers
bidding lower for cash cattle and they could very well find some takers since
those producers that have short-hedged their cattle will be happy to take the
gains on their hedges and let the cash cattle go at lower money. Further, the
underlying fundamentals in the cattle market haven’t looked all that great
lately. Steer weights were reported up 3 pounds this week when they should
be trending seasonally lower. The DTDS weights shot higher and are now
close to +30 lbs. Beef demand also looks pretty shaky, with the Choice
cutout losing -2.90/cwt on a weekly average basis and the Select down
$2.67/cwt. Late April is not the time of year one would expect the beef
market to head south. As a result, a lot of buyers taking delivery on those
forward beef orders in the next few weeks will likely end up paying well
above the spot market and that often creates the temptation to find an
excuse to trim the order back or evade delivery.

Many retailers may be finding that beef simply isn’t moving out of stores
as quickly as they anticipated. Very high retail pricing and the lack of
attractive features is starting to take it’s toll on consumers’ willingness to
put that package of beef in their cart. The cure for that is to lower retail
prices but with inflation surging in nearly every item that consumers buy,
retailers have very little incentive to take retail beef prices down. So how
to solve this problem? Well beef is a perishable product and if it isn’t
moving well out of grocery stores, it will soon start to back up at the
packing level. Packers will be forced to lower wholesale prices and, since
their margins are already pretty thin compared to what they’ve had over
the last couple of years, they will look to pressure the cash cattle market
lower. Cattle feeders will find that their ability to resist lower pricing is
limited because of big placements in the past that are now starting to
become market ready. So, while average cattle prices were higher this
week, the conditions are setting up to take them lower in the weeks to
come.

But what about the spring rally in beef prices? I hate to say it, but there
might not be much of a spring rally this year. My initial target was for the
Choice cutout to top around $295 this spring, but each week I’m finding
that the beef market isn’t performing well enough to justify that and so the
target gets lowered. Now I’m thinking it may be a stretch to get the
Choice cutout to $280. The attached chart shows the contribution of each
primal to the cutout this week. Naturally, our eyes will be drawn to the
negative bars on the end meat primals and that indeed is a problem, but
the bigger problem is that we aren’t seeing the big positive bars in the
middle meats that normally occurs at this time of year. Notice that the
combined margin chart is also signaling some problems with demand. It
turned sharply lower this week and if that continues next week, it would be
a strong sign that the spring price tops in the beef market may be in for
this year. I’m still holding out hope that the middle meats will spring to life
and help produce at least a modest rally from here, but it is far from
certain. This week’s fed kill is estimated at 515k, up over 20k from last
week.

That means more beef that has to clear the system next week, although a
good bit should be headed for delivery to customers who booked ahead.
Market ready supplies of cattle should continue to grow right through June
based on past placement patterns, so if the cutout is struggling now, what
will happen in June when weekly fed kills could approach 530k or more?
Today’s Cattle on Feed report indicated that feedyard inventories are now
the largest on record for April 1st and 1.7% higher than last year at this
time. Like I’ve said many times in recent weeks, feedyards are brimming
with heavy cattle. Unfortunately for cattle feeders, the financial aspect of
this market is likely to get a lot worse before it gets better, especially since
they are now paying $8/bushel for corn. Beef buyers should be the
beneficiaries, but what good is it to buy beef cheap if consumers aren’t
enthusiastic about taking it off your hands? I suspect this is going to be a
very interesting market over the next couple of months, starting with the
futures open on Monday.