Pork Wrap March 4
They say that all good things must eventually come to an end and this
week the cutout party that had been going on since Christmas came to an
abrupt stop. The pork cutout dropped $3.23 on a weekly average basis
and was pushed lower by a big drop in belly prices. The bellies had
reached very high levels and were starting to look toppy, but a sharply
lower print on Thursday sealed the deal for them. This is the way that
cutout rallies often end—with the bellies crashing from a high level and that causes buyers for the other parts of the carcass to take a step back.
When they do that, it creates a small air pocket in demand that the other
primals fall into. That is the real risk here. Beef cutouts have been
showing us the blueprint for what is next in pork and this week the
downtrend got started. The combined margin chart clearly indicates that
the demand upcycle that has characterized the market since Christmas
has now peaked. It is worth noting that this peak was below any of the
other peaks that we saw during the super-strong demand environment of
2021.
It looks to me like pork demand is working back down to more-normal,
pre-pandemic levels. Beef is now more competitive with pork than it has
been in a long time and that should catch the eye of retailers as they plan
their spring features. That means that demand for the retail primals will
likely come under pressure in the next few weeks and help move the
cutout lower. The decline shouldn’t be huge because there are a couple
of factors that will soften the blow. The first is that the spring grilling
season is fast approaching and that should keep retail pork demand from
sagging too much. The second is that kills will be declining seasonally
over the next few months and so prices will get some support from the
supply side. I am currently forecasting the cutout to pull back into the
upper $90s before moving higher in April, but I do think there is more risk
that the cutout slips lower than that. That should put some pressure on
the LHI, which averaged $99.68 this week. How much pressure depends
on how the negotiated market reacts to the declining cutout. Negotiated
prices forged higher this week, even as the cutout was slipping.
The NND market added $6.21. That squeezed packer margins down to
only $15/head—the lowest they have been since September. I think there
is a real danger that margins fall below $10/head next week. Packers are
already working on margin management by slashing the Saturday kill.
Packers only plan to slaughter 59,000 head tomorrow compared to
126,000 on the previous Saturday. That brought this week’s total to 2.43
million head, down from 2.5 million last week. We are now working on
the Sep/Nov pig crop, which was estimated down 3.6% YOY. This
week’s kill was about 20k below what the pig crop implied. The working
theory is that unusually high incidence of PRRS in the Western Corn Belt
is limiting hog supplies in that region and that is what has kept negotiated
prices so firm over the past month or so. During the month of February,
the WCB price averaged $6.27 over the NDD. That is the biggest spread
ever recorded. The 10-year average spread for February is less than $1.
We saw a similar thing happen last spring during May and June where
the WCB ran at a $5 premium to the NDD. If you remember, that was a
period of rapidly escalating hog and pork prices. This spread warrants
close watching in the next few weeks to see if it narrows up when
packer margins come under further pressure. If it doesn’t then that is
probably a good indicator that hog numbers in the WCB are really tight
and we can expect packers to be timid with the kill in an effort to keep
the cutout high enough to preserve their margin. I’m looking for kills to
run in the low 2.4 million head area for most of March and then move
into the high-to-mid 2.3 million head area for all of April. If kills during
this Mar/May quarter start to run consistently below what USDA’s pig
crop suggest then that could be an indicator that disease problems
have resulted in smaller litters or higher death loss than normal.
Producer margins were +13/head this week, only the third positive
margin of 2022 so far.
However, I expect that producers will soon move back into the red as
their breakevens escalate and prices in the hog and pork complex cycle
lower. Today’s breakevens are just a tad over $93/cwt, but they are set
to rise to $99/head by the end of April. If the corn and soymeal futures
keep pressing higher, then it is very likely hog producers will have
breakevens over $100 this summer. That, in turn, means producers
won’t be wildly profitable and might even see negative margins for a
while during the period of the year when they normally make the most
money. That should dampen any desire they might have to expand
their herd. The export markets certainly aren’t offering producers a lot
of hope these days. Thursday’s weekly export data showed total pork
exports down 25% YOY. China has moved back to being a minor
player for US pork exports. It seems very likely that, going forward, hog
and pork prices will need to be above pre-pandemic norms as
producers struggle to cover all of their escalating input costs. Last year
a super-strong demand pull bailed producers out, but that doesn’t
appear to be in the cards this year.
As a result, I’m projecting 2022 margins to average around -$10/head.
Last year, they were a little over +$8/head. The futures market began
the week higher and at one point nearby Apr traded $107.45, but that
all came to an abrupt end when traders started to sense the belly
collapse. Apr finished the week at $100.45, which was less than $1
higher than the current LHI. That contract may be about to transition
from negative to positive basis. If the demand cycle has really turned
now and the cutout is going to ease for a few weeks, then futures
traders are likely to want to keep the nearby modestly discount to the
LHI. Next week, it is all eyes on the bellies to see how far and how fast
they slide.
