Pork Wraps

The hog and pork complex continued to ease lower this week as
the cutout dropped $3.02/cwt and the WCB negotiated market
was down $3.32/cwt. The losses in the cutout were largely
driven by big declines in the belly primal. Hams also moved a
little lower, but the downtrend there seems to be slowing.
Perhaps the most surprising event this week was the collapse of
the Oct futures, which lost close to $7. It is not unusual for the
next nearby contract to make a big move around the time when
the front month expires, but I had assumed that move would be
upward this time because of the large gap between the LHI and
the Oct contract when the Aug expired. Instead, traders sensed
that a top had been made in the cash market and the fear of a
rapid price decline created a lot of selling pressure in the
futures. That futures selloff took the Oct contract down close to
my forecast for the LHI at Oct expiration, so it is now very close
to fair value.

However, I think the risk to that forecast lies to the upside and
could easily see the Oct contract expiring $5-10 over the $93
level where it traded today. The combined margin continued
lower this week, helping to confirm that a new downcycle in
demand is firmly in place. If you look closely at the combined
margin chart, you will see that hog producers are the ones
making all of the money in the current market and packers
actually posted a small negative margin this week. That gives
you an idea of who has the upper hand in this market:
producers. The supply of uncommitted, market-ready hogs
remains very tight and as a result, packers continue to pay a lot
for the spot hogs they need to fill out their kill schedules. It is
that tight supply of uncommitted hogs that makes me think
prices in the hog and pork complex won’t decline as fast as the
futures wanted to imply this week.

Of course, hog supplies will grow a little every week as the
seasonal expansion takes hold, so prices should slowly work
lower, but they probably won’t come crashing down as they
have in some years. Skinny packer margins are a symptom of
not enough hogs to meet slaughter capacity and it is pretty
uncommon for packers to still have negative margins this deep
into August. In fact, the last time that packer margins went
negative in the third week of August was 15 years ago. Even in
2014 when PEDv slashed hog supplies, packers managed a
small positive margin throughout August. So, the supply side is
pretty tight. Barrow and gilt carcass weights were reported
another pound lower this week and the DTDS weights also
moved lower.

That is another sign of tightness in the hog supply. This week’s kill
registered just a little shy of 2.4 million head, with a small Saturday kill.
Once again, slaughter was below what the Dec/Feb pig crop projected.
It now looks like USDA might have over-estimated that pig crop by as
much as 700k head. Next week’s kill should also be near 2.4 million
head and then there will be two smaller kill weeks around the Labor
Day holiday.Packers will likely give employees the Saturday before
Labor Day off, which will reduce the kill in the week prior to Labor Day,
and then there will be no kill on Monday of Labor Day week. The
holiday will provide packers with a chance to rebalance the hog supply
with capacity and perhaps get their margins back in the black. As we
move into September, the industry will begin killing the Mar/May pig
crop, which was reported by USDA to be down 1% from last year.
Given that USDA clearly over-estimated the Dec/Feb pig crop, we
shouldn’t be surprised if they are a little too high on the Mar/May as
well.

Domestic pork demand does seem to be slowing a little, but most of
that seems to be concentrated in the processing items. Butts
continued working lower this week and are nearly back to where they
were this spring before the great summer rally began. Picnics seem
to be following the same pattern as butts, only a month or so behind
them. Picnics are currently topping and are forecast lower from here.
The trim products remain firm and that could slow the decline in the
picnics, which are often used in the same applications as trim. Loins
should see good retail interest just after Labor Day and so I think they
can hold current values for a few weeks longer. There is not much
doubt that the majority of pork items will see lower pricing in the next
couple of months as hog supplies expand and the demand downcycle
continues.

There is less certainty around how fast the price declines will come.
With spot hog supplies so tight, packers may have to keep the kill
contained by necessity and thus the product markets could outperform
my forecasts in the next few weeks. There isn’t much new to report in
the export markets. Weekly volumes seem to have stabilized at a level
that is about 5-10% below last year and I don’t see any reason for that
to change in the next couple of months. Next week, look for the cutout
and the negotiated hog markets to continue to ease as supplies slowly
grow. Futures are likely to recover some of this week’s huge selloff.