Pork Wraps

Well, it finally happened. The pork market underwent a major
downward correction this week, led by the bellies. It started on
Tuesday morning when the AM pork report showed the belly
primal sharply lower on big volume. By that afternoon, the cutout
printed down $12 from the day before as the bellies were joined
by the hams and the trims in sharp decline. Any hopes that the
pork market would quickly recover were dashed as the cutout
stayed in the low $100s for the remainder of the week. In the
end, the cutout averaged $106.11, down a little over $14/cwt from
the previous week. Futures traders had been sensing for some
time that a big correction was near as the Oct contract sold off the
week before and was carrying a huge discount to the LHI. The
futures continued lower on this week’s pork collapse, but the
week-over-week losses were not huge because much of the
selling had taken place the week before.

I don’t think anyone expected the sky-high hog and pork prices
from August to continue unabated into fall. A correction was
needed and it came swiftly. That is the way it works in the hog
and pork complex. The market will grind higher for months when
it is on the rise, but when it moves lower it is often sharp and
deep. Consider that the pork cutout was trading around $107
back in May just before Memorial Day and it took all summer for it
to peak near $127 (weekly average) in early August. Now, just
three weeks later, the cutout is back below $107. As is often the
case, when the pork corrects lower, the negotiated hog market
isn’t too far behind. Producers know that when the cutout tanks
that packer margins go deeply red and they will slash the kill if
they can’t get hogs bought cheaper. Rather than risk a backlog
of hogs, producers begin to accept lower negotiated prices.

This week the WCB negotiated market dropped about $3.50 to
average $125.15/cwt and further, faster declines are likely on tap
for next week. I calculate packer margins this week at -$24/head,
but some of that is because the LHI hasn’t yet caught up to the
rapid decline in the cutout. But clearly packers are in the red and
they responded by producing a rather tepid kill this week of 2.39
million head, with a very small Saturday kill. Further, they have
two short kill weeks on the horizon due to Labor Day, so that will
allow them to do some margin management without having to be
obvious about their motives. This week’s small kill and the two to
come will likely stabilize the cutout in the low $100s and could
even cause it to increase some. Bellies are now so cheap that it
is hard to see much further downside in that primal. Hams are
likely to have further downside risk, but the small kills should help
slow the decline.

Trim prices should also get some support from the small kill and
processing downtime around the holiday. The retail primals appear to
be in good shape. There were some modest declines in the loins, butts,
pics and ribs this week, but that was probably cause more from buyers
hitting the pause button while they watched the cutout fall and they will
likely be back in the market next week. So, I don’t see a lot more
downside risk in the cutout over the next few weeks. My guess is that it
will wallow around in the low $100 to maybe high $90s through the first
half of September. Growing kills as fall progresses are likely to push the
cutout into the low $90s during October. The big reset has happened
now and once market participants catch their breath and think things
through, I suspect that the fear will abate and thus allow the market to
trade with more confidence next week. If the cutout and negotiated
markets were to hold where they are today, then the LHI should settle in
somewhere in the $105-107 range.

That is still a very long way from the near-$90 price that traders are
putting on the Oct LH futures. Interestingly, the pork cutout futures
settled today just over $101, which indicates that traders don’t think the
cutout is going to decline much between now and the middle of October.
In fact, I’d guess that most traders believe there is a rebound in the
cutout coming and that it will move higher before trading lower into
expiration. I can see that scenario playing out also. As a result, I think
the risk to my forecast is that prices turn out to be somewhat higher than
what I currently have dialed in. Slaughter this week was once again
lower than what the pig crop implied and since this was the last
slaughter week of the quarter, we can see now that slaughter during the
Jun/Aug quarter was close to 700k below what the pig crop implied.
Expect packers to do a very light Friday and Saturday kill next week and
of course there will be no kill a week from Monday.

Carcass weights moved one pound lower this week and are likely now at
their annual low. Weights should increase steadily during the fall as
cooler weather fosters faster gains. USDA didn’t report any usable trade
data this week, but it probably wouldn’t have shown much improvement
in the export picture if they had. Next week, look for the pork market to
settle down and perhaps even advance some as buyers anticipate the
short kills ahead. Watch the negotiated markets. For most of the
summer the story has been one of exceptionally tight uncommitted hog
supplies. This recent reset in the pork market will be a good test of just
how tight the spot hog market is now. If packers push it lower with ease
then maybe supplies are not so tight, but if negotiated prices remain
stubbornly high then that would be strong evidence that the shortfall in
uncommitted hogs is real.