Pork Wrap July 30
The pork cutout added a little over $2 this week, but the cash hog
markets remained on the defensive. The WCB negotiated market
declined about $3 on a weekly average basis. With the negotiated
market moving lower and the cutout moving higher, the LHI stayed
essentially flat on the week. In fact, the LHI is at nearly the same
level it was when the July contract expired over two weeks ago
($112). That didn’t stop the futures from selling off this week, with
the Oct contract losing over $4.50.
Traders are likely becoming more pessimistic about the export
prospects for this fall since the recent weekly export data hasn’t
looked all that good. In addition, there may be concern that hog
supplies this fall will test packing capacity, which has been limited
by labor shortages. But while the futures market was becoming
more bearish, I was becoming more bullish. I was forced into a
major forecast revision this week because the strength in the
cutout has not abated as quickly as I anticipated. Trim markets are
on fire and sow prices are heading higher rapidly. I pushed the
price forecast for nearly all of the primals higher over the next
several months. That, in combination with the futures selloff,
helped to remove a lot of the mis-pricing from the fall and winter
contracts. I’m also now showing Aug as under-priced given that
the index hasn’t moved in two weeks and the contract only has 10
more trading days until expiration.
At today’s close, the Aug contract is nearly $6 under the LHI and
that gap seems excessively wide for a market where the index
hasn’t shown much movement. Pork demand seems to be back on
the rise, as indicated by the combined margin chart below. I
thought that perhaps the combined margin was giving us a head
fake by moving higher a few weeks back, but now it is hard to deny
that an uptrend is back in place. At the same time, hog supplies
have been slow to expand after reaching a bottom around
Independence Day. This week’s kill was estimated at 2.33 million
head, essentially unchanged from the week before. That was less
than the pig crop projected and the chart below shows that with
four weeks to go in the quarter, the cumulative under-kill of the pig
crop has amounted to around 800k head. If these under-kills
continue, we will likely experience a total shortfall of about 1.1
million head for the quarter. You would think that with actual hog
supplies tighter than expected during the summer, that hog prices
would be rising and packer margins would be tight. Instead, the
opposite is true.
Packer margins this week came in at close to $21/head, a $5
increase from last week and a really hefty margin for this time
of year. Packers are simply not interested in pressing the kill
higher and that probably has something to do with the tight
labor situation. So, it is like they are in margin management
mode without having any actual margin problem. So far, the
carcass weight data isn’t indicating any significant back up of
hogs in the system and in fact the DTDS weights are near all-time lows.
I expect that packers won’t let the margin get much bigger
without sharing some of it with producers and so if the cutout
continues to strengthen, I think it increases the chances that
negotiated hog markets stop declining. I’m not looking for a lot
more strength in the cutout from current levels, but I could be
wrong about that. The belly primal made another all-time high
this week and 42s averaged an astounding $131. The small
kill this week could support the cutout again next week.
Looking further out, it does worry me that USDA seems to have
missed the current pig crop so badly and raises the possibility
that they also underestimated the Mar/May pig crop, which we
will begin killing in September. The government told us that
the Mar/May pig crop was down 3.1%, so if they were too high
on that we might be looking at something closer to a 5% YOY
decline in hog availability this fall. If that is the case then we
won’t likely see the type of price decline that normally happens
in the fall.
I’m still rating the Oct and Dec contracts as too high, but that is
probably not the case if it turns out the Mar/May pig crop was
underestimated. On the demand side, if the current COVID
wave intensifies in the fall, it will likely cause a resurgence in
stay-at-home behaviors and we already know from experience
that is strongly positive for red meat demand. So the perfect
storm this fall would be for COVID to surge and the pig crop to
be smaller than expected. Next week, watch the negotiated
hog markets for signs that they are slowing their descent or
even bottoming.
