Pork Wraps

The hog and pork complex remained stuck in neutral for yet another
week. The WCB cash market averaged $0.25 lower on the week,
while NDD cash market posted a $0.94 gain. The cutout managed
$0.33 higher on a weekly average basis. As a result, the LHI was
almost unchanged on the week, averaging $71.93. It feels like
participants all up and down the supply chain are just waiting to see
what happens next. Last week’s Christmas-shortened kill was the
second smallest weekly kill of the year, yet the cutout went nowhere in
the ensuing days. That is because buyers also take the holidays off
and plan well in advance for these last weeks of the year. The real
challenge will come next week when buyers are back at their desks
and pork production ramps back up to non-holiday levels.

I am seeing some signs in the retail cuts that they may be poised to
move higher in the next few weeks. We’ve already seen some steady
price increases in the butts and ribs, but I think now the loin primal
could start to attract some interest. The worst is probably over for the
hams and their next move should be higher, but it will be more of a
slow steady grind higher rather than a rocket launch. The chart below
indicates that the hams were the biggest drag on the cutout again this
week, but modest improvements in belly pricing largely offset the
weakness in the hams. Overall pork demand appeared to be making a
near-term bottom a couple of weeks back, but the combined margin
chart indicates that the holiday period disrupted any chance for it to
gain traction. Now that the holidays are behind us, perhaps that
demand upcycle will get back on track. Soaring omicron infections in
the US remain a potential risk/benefit to pork demand. The risk part
lies with the possibility that so many consumers get sick that they just
don’t feel like eating at all and certainly don’t feel like going to the
grocery store.

The benefit potential is related to the chance that consumers return to a
stay-at-home approach for a while and thus shift a significant portion of
their consumption from the foodservice channel to retail, which we
already know is positive for demand. Another risk from the omicron
surge is the potential for plant workers to get sick en masse and thus
cause packers to have to scale back the kill substantially. This seems
like a very real possibility that hasn’t been talked about nearly enough.
So far, the daily kills have held up well, but states where most hog
packing plants are located have yet to see the surge like the coastal
states have. It is just a matter of time before states like Iowa see huge
spikes in infections. North Carolina, where the largest hog slaughter
facility in the nation is located, is now recording huge increases. It is
true that the packing plant workforce is more than 90% vaccinated, but
this variant seems to make people sick in spite of being vaccinated.
And then there is the issue of kids, who are getting sick in record
numbers. That could cause school closures in early January and thus
generate high absenteeism as plant workers stay home to care for their
kids.

Keep in mind that hog supplies are seasonally very large. This
would be a bad time to lose a chunk of processing capacity. If
plants do get constrained by labor problems, then I think we can
expect the cutout to rally as buyers get shorted and we would
probably see some retrenchment in the negotiated hog markets.
Any such labor constriction probably wouldn’t last very long,
perhaps 2-3 weeks, because people infected with this variant seem
to recover rather quickly, especially if they are vaccinated.
Epidemiologists tell us that we are likely to see a huge and rapid
spike in infections and then a very quick decline. So the worst of it
might be over by the end of January, but it could do plenty of
damage to the pork supply chain in just a few weeks. This week’s
kill looks like it is on track to come in at 2.16 million head, but we
won’t know for sure until Monday because Friday was a
USDA holiday.

Next week, I see the kill bouncing back to about 2.45 million
head if covid doesn’t cause too many problems. Kills are still
coming in a little above what the prior pig crop implied, but the
over-killing doesn’t seem to be as severe as it was in the recently
completed Sep/Nov quarter. USDA reported barrow and gilt
weights down a pound this week, but they could bounce back in the
next couple of data reports that will cover the holiday period. At
present, weights seem to be pretty normal and don’t indicate any
backing up in the pipeline. With demand due to cycle higher
and supplies potentially getting crimped by covid, the
potential for higher pork prices in the next few weeks is high.
Traders who were long the February contract seemed to grow tired
of waiting for some upward movement in the lean hog index and
that contract lost almost $2 on the week. More importantly, the
spread between the Feb pork cutout futures and the Feb hog
futures increased substantially this week and that shows that
traders are revising their expectations for packer margins in
February upward.

Packer margin expansion is exactly what we would expect to
happen if processing capacity gets compromised, so it looks like
traders are starting to position themselves for a higher probability
of slaughter disruptions in the weeks ahead. In all though, the
futures curve doesn’t look too far out of line with my
fundamental forecast, at least through June, and the supply
picture beyond June depends on pig crops that haven’t been born
yet. Next week, watch the daily covid infection counts and watch
the daily slaughter numbers for signs that throughput is being
affected by the virus. The omicron surge is going to be the main
story of interest for the next couple of weeks.