Pork Wraps

The bulls in the hog market had been frustrated in recent weeks by
softer cutouts and mostly sideways LHI. However, when the cutout
showed a modest amount of strength this week, the bulls exploded
onto the scene, forcing the Jun contract up almost $10/cwt. That
really seems like an excessive reaction in a week where the cutout
only gained $1.95 and the WCB negotiated market was flat with the
week before. I chalk it up to pent-up bullish enthusiasm. Now comes
the hard part. The market has to live up to the high expectations that
futures traders have set for it. We have been waiting for the pork
demand cycle to turn higher and it may have accomplished that this
week. The combined margin is showing a slight uptick, but we have
seen those before and then the combined margin continued lower.
The gain in the cutout this week was driven by stronger ham pricing,
with a little help from the butts and picnics.

There were a couple of points during the week where the bellies
looked like they were about to surge higher and perhaps that is part of
what stoked the futures so much today. However, those all turned
out to be false signals generated by light volumes. The up-move in
ham prices is definitely real however, and it could be driven by
stronger export business to Mexico. By now, all of the Easter hams
for US retailers have been bought and processed, so I doubt that it is
stronger domestic demand that has been moving ham prices higher.
We are definitely seeing more boneless hams in the mix these days
and that has the effect of raising the ham primal value. I have to
surmise that packers are seeing labor availability improve. That is
important for sure, but prices for bone-in hams have also been
moving higher recently and when we combine the two effects, the
result is stronger ham primal values. I’m a little surprised that loins
haven’t performed better since that is a retail favorite for grilling
season.

Perhaps we are just not far along enough in the calendar for that to
occur. It is also possible that the modest upward turn in the cutout
this week has its origins in smaller pork production rather than any
significant demand strength. Kills are working seasonally lower now
and this week’s total came in at 2.42 million head, about 10k less than
the week before and about 20k less than what the Sep/Nov pig crop
implied. That is not a very big deviation from the pig crop, so for now
I’m assuming that USDA was pretty close in its estimate. There has
been a lot of speculation about disease problems limiting the supply
of hogs, but if that were the case I would expect to see kills coming in
way below the pig crop estimate and so far that hasn’t happened.
We will get a clearer picture on Wednesday when USDA releases its
next issue of Hogs and Pigs.

I’ve included a table here that provides the average trade estimate
for the important numbers in that report along with the JSF
projections. Expectations are for the total herd and breeding herd to
be down only slightly from last year, with a modest gain in the pig
crop due to productivity improvements. If there are more disease
problems than normal, then I would expect it to show up in a weak
pigs-saved-per-litter number and perhaps smaller than expected
farrowings. I think that the biggest risk heading into this report is
that it will show more contraction in the herd than the average trade
or JSF’s forecast. If that happens, it could be like throwing gasoline
on a fire in the futures because the summer contracts have been
exceedingly bullish and a smaller-than-expected pig crop would
have the effect of confirming the bulls’ bias.

If it goes the other way and supplies are reported larger than
expected, I suspect it won’t have near the same effect to the
downside. The bulls in the market seem to be pretty resolute right
now. They honestly believe that hog supplies are going to be very
tight this summer and no amount of USDA data will convince them
otherwise. It is interesting that the WCB negotiated price seems to
have stalled out around $110/cwt for the past couple of weeks.
Perhaps packers have adjusted their slaughter expectations
downward to better fit available supplies. This week the WCB cash
hog price was more than $3 higher than the cutout. That is a very
unusual occurrence, but it does point toward very small packer
margins. I have this week’s margin at $8/head, with risk that it
shrinks even more if the cutout struggles to hold on to the small gain
it made this week. Producer margins are larger than packer
margins, which is also a very rare occurrence. This week’s
producer margin was about $11/head.

Prior to 2020, it wasn’t unusual to see producers $10-20/head in the
red during March. Last year, producer margins averaged a little
over +$8/head—their best margin since 2014. I don’t think they will
be able to build on that this year with corn prices so high and
demand likely to fade from last year’s level. More likely, the
average margin for 2022 will be below zero and perhaps by a
substantial amount. That makes the decision not to expand the
herd look very smart in the current environment. Next week, we will
be watching for confirmation that the demand cycle has turned
higher and a stronger cutout would be the first clue. Futures traders
have already placed their bets that the upcycle has begun. There
could be a rather strong negative reaction if that turns out not to be
the case.