Pork Wraps

The pork cutout rebounded this week, gaining $2.80/cwt to average
$103.57. That is still a bit below the $106 average that has
characterized the pork market since the middle of February, but does
help erase some of the bearishness that was prevalent the week
before when the cutout dipped below $100 and thus enabled the May
lean hog futures to expire near $100. The attached chart shows that it
was gains in belly pricing that were largely behind this week’s cutout
improvement. Hams also showed some price gains, but they started
the week with a couple of low prints, so the weekly average didn’t
reach the previous week’s level. All of the retail primals were rather
ho-hum—just churning along in a sideways pattern as they have been
for the past couple of months. It has really gotten to the point where
movement in the cutout is primarily dependent upon price changes in
either the bellies or the hams. Of course it won’t stay that way forever,
but right now that seems to be program. The negotiated hog market
moved higher this week, with the WCB adding $1.74/cwt on a weekly
average basis and the National negotiated market up $3.23/cwt.

Those gains, combined with the improvement in the cutout, helped to
break the LHI out of its downtrend and got it moving higher toward the
end of the week. Further gains in the Index are expected next week as
the negotiated improvements flow fully into the calculation. If the
cutout and the cash hog market were to remain where they were at the
end of this week then the LHI should move into the $104-105 range.
Of course, futures traders got excited about the cash market
improvements and added $8 back on the Jun and Jul contracts after
taking almost $6 off of the Jul contract the week before. This is
characteristic of a directionless market, where traders simply react to
the day-to-day movements in the cash market fundamentals. Right
now it looks to traders like the market is going up, but in reality it is
probably just coming back toward that $106 average cutout that has
been the norm for so long. In order to reach the $109 value that
traders put on the Jun contract today, the cutout is going to need to
break out of its trading range and move above $110.

The combined margin moved a little higher this week and although it
looks like it might have bottomed just below the zero line, I want to see
how next week’s data comes in before declaring that demand has
moved back into an upcycle. All of the last-minute buying for Memorial
Day is now behind us, but that was probably more important for the
retail primals than for the processing items. If both the hams and
bellies can move higher together, then that would be a powerful force
that could take the cutout several dollars higher next week. However,
even if demand is beginning a new upcycle, I suspect that it won’t be a
very long one or a very robust one given all of the demand-defeating
elements of the macroeconomy right now. Inflation, high energy prices
and a declining stock market should all work to temper pork demand in
the longer run.

Normally at this time of year, I would be pointing to shrinking pork
supplies as a supportive factor for hog and pork prices, but we actually
saw the kill increase this week to 2.41 million head. That is very similar
to the kill levels we saw back in March. It may be that packers are
anticipating doing a very small Saturday kill next weekend (Memorial
Day weekend) and thus are trying to build some inventory to
compensate. In any regard, it will be interesting to see if that puts
pressure on the pork market next week. This week’s kill was about
70,000 head greater than what the Sep/Nov pig crop implied and marks
the fourth week in a row where the industry has overkilled the pig crop.
That seems to suggest that there are plenty of market-ready hogs out
there, but the rise in negotiated prices this week suggests otherwise.
Packer margins improved this week to about $4/head after being -$2/
head last week. I suspect that packers are going to struggle with
margin problems for the next couple of months.

Recall that the industry added several large packing plants back in
2018-19 in anticipation of growing export demand and a bigger hog
herd. Well, now export demand is in decline and high input costs
are causing producers to shrink the hog herd. If plants want to run
at a reasonable capacity utilization rate, they may be forced to chase
hogs this summer and that could have a detrimental impact on
margins. If they have to chase hogs while demand is declining, that
would be particularly bad for their profitability. Hopefully, demand is
going to turn higher soon and a stronger cutout this summer will
leave packers more room to pay up for hogs. It doesn’t look like the
export market is going to bail them out this summer. China is still
dis-interested in S pork and that could get worse as COVID
lockdowns and port congestion continue. There is a good possibility
that China’s economy is going to slump throughout the balance of
2022 and that wouldn’t be good for US pork exports. Producers
are still struggling to turn a profit, despite the triple-digit cutout and
hog pricing.

High input costs have now pushed their breakevens close to $103/
cwt. That could lead to further reductions in the breeding herd and
smaller supplies down the road. We get another look at the breeding
herd when USDA releases the next edition of Hogs and Pigs on June
29. Corn futures pulled back a bit this week, but given that the crop
is not even fully planted, I don’t expect traders to let it decline a lot more
from here. As long as there is war in Ukraine and oil prices are in triple
digits, it is a good bet that corn will remain above $7/bushel and could
go as high as $9-10/bushel under the right circumstances. Next
week, watch the cutout to see how it is going to respond to this week’s
larger-than-expected production. If we do see further increases, that
will likely add to the bullishness in the nearby futures and most
likely will push it well above what it is capable of achieving before
the Jun contract expires in three weeks.