Beef Wraps

Beef packers’ margin situation got a little more precarious this week as the
cutouts turned lower yet cash cattle continued higher. On a weekly average
basis, the Choice cutout lost $2.27/cwt and the Select was down $0.56/cwt.
Thus it looks like the rally in boxes that began in mid-May has now run its
course. The attached chart shows that it was the middle meats that were
responsible for pushing the cutout lower this week. The chuck, which
traded higher, tried to help, but fell short. With Father’s Day now behind us
and all of the buying for July 4 now completed, it isn’t too surprising that the
middles would come under pressure. It seems to me that this was just the
first step in a series of weekly price declines for middle meats. In addition
to the weakness in the middles, fat trim finally posted lower pricing this
week. That could be related to the completion of July 4 buying, or it could
be that kills have just been so big lately that some supply-side pressure is
beginning to show up in the trim. Lean trim seems to be holding up very
well and we saw the 90s price gain about $2 this week.

As the macroeconomic conditions deteriorate over the next few months, it is
reasonable to expect stronger ground beef demand and weaker middle
meat demand as consumers increasingly trade down toward cheaper
proteins. While the beef market was struggling this week, the cattle market
continued to advance. The average price of cash cattle increased almost
$1 to $144.50. Cattle in the North traded at $146 or better and in the South
the trade was at $138 or a little lower. That is a huge regional price
differential. Back in pre-pandemic times, when cash prices differed that
much between regions, packers would buy cattle in the low price region and
then truck them to the higher price region. They would usually only need to
do that for a few weeks before prices would equalize. Now I’m wondering if
this big price differential is persisting because of a much higher cost to
transport cattle. High fuel costs and shortages of truck drivers might be
making it cost-prohibitive to buy cattle in one region and slaughter them in
another. Regardless of the cause, the inability of packers to get cattle
bought cheaper is going to become a real problem in the weeks ahead as
the cutouts move lower.

I calculate this week’s packer margin at $155/head and am projecting
margins less than $100/head in the coming weeks. Cattle feeders, on the
other hand, are seeing their margins improve. The combined margin turned
lower this week and it now looks like the industry has moved back into a
demand downcycle. Close inspection of the combined margin chart
indicates that the last 4 demand cycles have peaked at lower and lower
levels. The most recent demand cycle was particularly anemic and it looks
to me like the combined margin will be in negative territory soon. Given
that feedyards are full of cattle, the combination of weaker demand and big
supply points to lower cattle and beef pricing down the road. This week’s fed
kill came in at 523k, almost identical to the week before. Next week, I
expect that packers will leverage the holiday weekend to do a very small
Saturday kill and thus keep the fed kill in the 500-510k range. It is the
perfect excuse to cut the kill and make it look like they want to be nice to
their workers by giving them a long weekend. The official July 4 holiday is a
week from Monday, but it is common for packers to pull back on the
Saturday before when the holiday falls on a Monday.

Then the following week, there will be no kill on Monday and so the fed kill
might fall as low as 470k. So for the next two weeks packers have a prime
opportunity to cut kills and hopefully strengthen their margins. The smaller
kills might not be enough to boost the beef market, but it almost certainly
will help stop the price increases in the cash cattle market. Cattle carcass
weights continue to drop. Steer weights were reported down another 3
pounds this week. We are way beyond the normal point in the calendar
where weights bottom. If nothing else, the upcoming short kill weeks will
likely cause carcass weights to turn higher. The DTDS weights continued
to plunge this week, dropping to -10 lbs after registering +30 lbs just a few
weeks back. There are a number of theories floating around about why
packers keep having to pay up for cattle when the number of cattle on feed
is record large. One of them is that they are “chasing the grade”. Another
is that they need to fill previously booked orders.

But the weight data is very clear and it tells me that a lot of cattle are just
not ready for slaughter right now. Maybe it is the heat or maybe it is a
change in rations by cattle feeders, but the front end supply is quite current
judging by what weights are telling us. It is true that there are record
numbers of cattle in the nation’s feedyards, but that supply must be tilted
more toward July and August than June. USDA gave us another look at
the cattle supply in today’s Cattle on Feed report. They pegged
placements during May down 2.1% and June 1 on-feed totals up 1.2% and
the largest on record for this time of year (since 1996). The placement
number was about 2% smaller than what analysts were expecting, so it
might generate some buying in the futures on Monday, but I believe that
traders are now more focused on potential demand problems down the
road and so any rally generated by the COF numbers is likely to be shortlived. This week the contracts on the front end of the futures curve lost
between $2.50-$3.00 as traders grew increasingly concerned about what
high inflation and a cratering stock market would mean for beef demand. I
definitely agree with them that these are the things that will determine
pricing across the complex in the coming months.

Gasoline prices have started to ease a tiny bit but still remain very high and
with each passing day that is putting more strain on consumer’s budgets.
Interest rates are rising and it won’t be long before that starts to seriously
impact housing prices. Declining housing values are a lot like declining
stock prices—it makes consumers feel poorer and thus curtail spending on
non-essentials. We can already tell from the combined margin chart that
beef demand is way off of its 2021 levels. So beef demand is coming into
this period of macro headwinds in an already weak position. That causes
me to think that things could really get ugly on the demand side over the
balance of the year. Buyers would be wise not to extend coverage very far
into the future unless it is at price levels much lower than what we see
today. Next week, watch for further erosion in the cutout and keep an eye
on the Saturday kill because if it is exceptionally small that might be the
straw that breaks the cattle feeder’s back and finally gets cash cattle prices
heading lower.