Pork Wraps

After months of being stuck at roughly $105, the pork cutout finally
moved lower this week, averaging $100.77. A downturn in ham
prices combined with already soft belly prices to take $4.62 off of the
cutout this week. While the cutout was moving lower, cash hog prices
were moving higher. The WCB cash market added $2.42 this week
and the National market added $4.06. That was a bad combination
for packers and their margin dropped to -$2.70/head. That is the first
negative margin since last June when bellies collapsed and pushed
packer margins into the red for one week. Over the past three years,
there have been very few weeks where packers were running with
negative margins. My guess is that they will work quickly to try and
correct this problem before it gets any worse. They did reduce the kill
somewhat from last week’s rather large level, but even so it still
appears to be larger than what the pig crop implied. This week’s kill
was estimated at 2.38 million head, about 40k less than last week.

The attached chart indicates that was about 50k more than what was
expected. There are two weeks left in the March/May quarter and it
looks to me like the industry will over-kill the pig crop by about 200k.
That’s not a serious miss, but it could mean that kills during the
upcoming Jun/Aug quarter will also run a little larger than expected.
Barrow and gilt weights remain plateaued at 217 lbs and hopefully
they will start to move lower soon. There have been some very warm
temperatures in the Midwest recently and the forecast is calling for
warmer-than-normal weather next week, so perhaps that will be
enough to get weights started going lower. There will, of course, be a
short kill in the first week of June to account for the Memorial Day
holiday on May 30, but after that we should see weekly kills down
below 2.3 million head until the end of July. Kills should rise
seasonally in August and by the time the end of August arrives, we
could have slaughter levels back up to 2.5 million head per week.

I mentioned that packer margins were negative this week, but it is
important to note that producer margins were also negative by almost
$3 per head. That means the combined margin pushed into negative
territory this week for the first time since early in the year. The
combined margin is pretty close to where it bottomed last time, so
perhaps the demand softness has almost run its course for this cycle.
The main concern demand-wise is still the bellies and hams. Hams
clearly turned lower this week and the primal dropped almost $6/cwt.
Bellies also posted some soft numbers this week, although there was
an encouraging bounce in the primal on Friday. Hams I think will
continue lower next week. Bellies, I’m not so sure, but it is too early to
call them sharply higher. I want to see how they behave early next
week. The loins, butts and pics all seem to be trading relatively
steady and I’d guess that is likely to continue next week. The forecast
has the cutout just a tad lower next week and then moving back up
into the $105-110 range from Memorial Day onward.

To get to that forecast, I’m assuming that the downcycle in pork
demand is just about over and we will start to see seasonal
reductions in pork production soon. Both of those should be good
assumptions, but I’m more concerned about the demand side than
what will happen to supply. It is possible that the hams will continue
lower for longer than I imagine and thus keep the cutout depressed
for longer. Even futures traders are starting to grow wary of the pork
demand as they trimmed over $3 off of the Jun contract this week
and $5-6 off of the July and August contracts. By now, it is clear that
there is not a serious shortage of hogs that is going to cause price
levels to skyrocket this summer. I’m projecting the cutout to average
around $108-110 in June and July and the LHI getting back up to
perhaps the $105-107 area.

That’s not a huge gain from today’s levels and certainly well below
what traders were thinking this spring when they ran the Jun hog
futures up to $127. After running the futures up way too high and
then getting burned as the cash failed to live up to expectations, I’d
hope that futures traders will be more reserved this summer and
resist the urge to become wild-eyed bullish just because the cutout
moves up a few dollars. Further, there is the risk that packer’s
margin management efforts will be successful in pushing cash hog
prices down enough to offset a lot of the benefit to the LHI from a
stronger cutout. I think that the hog and pork complex will become
more bearish toward the middle of July because demand typically
sags after that and kills start to escalate. As a result, all of the
contracts from Aug onward look too rich relative to my take on the
fundamentals.

Export demand is still a lot softer than last year and with big imports
also, it is likely that pork availability this summer will be around 2%
larger than last year. If we throw in much softer demand than last
year, then there is no reason to think that price levels will get
anywhere near as high as they did last summer. Buyers would be
wise not to extend coverage too far into the future as things get
sorted out this summer. Corn prices remain very elevated and
producers are dealing with strong price inflation in a lot of other
inputs. That means breakevens will likely stay over $100/cwt for
much of the summer. Producer profitability is likely to be much worse
than what they have come to expect in the summer months and that
could lead to further reductions in the breeding herd later this year.
That is not necessarily bullish for price levels though, because
demand is expected to be working lower through the balance of 2022
also. Next week, watch the bellies for signs that the bottom is in and
also watch the hams because if the cutout moves lower, that will
likely be the primal that is to blame.