Pork Wraps

Remain abreast of the hogs & pork markets with our weekly Pork Wraps written by J.S. Ferraro EVP, Research and Analysis, Dr. Rob Murphy.

Pork Wrap November 26

The hog and pork complex has remained on a downward trajectory in
recent days. The pork cutout has lost almost $10 over the past seven
trading days and the NDD cash hog market is down $2.60 over the
same period. Futures traders have remained optimistic that a
turnaround is coming as the nearby Dec LH contract dropped less than
$2 and the pork cutout futures were down only $4 over the period.
Packer margins are shrinking as the losses in the cutout outpace the
decline in cash hogs. Packer margins averaged about $26/head last
week and will likely remain close to that this week. Those margins will
be about $10 per head less than where they were in early October,
when kills were smaller than they are today.

That suggests some modest tightening in the hog supply has occurred,
but pork buyers care very little about that. Instead, buyers are reacting
to softer demand from their customers and that is helping push pork
prices lower as we approach Thanksgiving. The softness in the cutout
over the past week and a half has been driven by softer belly, loin and
picnic pricing. Hams have held steady, but are beginning to look like
they might also soften in the days ahead. Without Chinese buyers
scooping up US pork with both hands like they have done in the past
two Novembers, price levels have sagged. It is clearly more of a
demand-side problem than anything on the supply side because kills
are running well below last year’s level. Last week’s kill clocked in at
2.63 million head and that may very well be the largest kill weekly kill of
Q4. My estimate for this week’s kill is right at 2.28 million head.
Packers are planning on a huge Saturday kill to help offset some of
what will be lost on Thursday. The smaller kill could support pork prices
next week, but it is not a sure thing. For one, bellies need to gain some
traction in order for the cutout to reverse its current downtrend, but this
is the time of year when belly demand for processing is generally light.
In the old days, November was prime time for users to move bellies into
the freezer as a hedge against high prices next spring.

In the last few years, there has been less of that “storage buying” in the
fall. As a result, I think there is a good chance that the belly primal
continues lower for another couple of weeks and may test the $100
level before it starts to move higher. At the same time it also looks like
the hams have topped and are starting to work slowly lower. One
reason is that boneless ham premiums to the bone-in have declined
recently, but the bigger effect is likely a softening of demand for
processing now that December is right around the corner. I find it hard
to forecast the cutout higher with bellies steady-weak and hams
softening in the next couple of weeks. Trim has also declined a lot
lately and there is little reason to call that higher in the near-term. I
think the retail items can hold close to current levels though and that
means that the downside risk in the cutout might be limited to the $80
mark—only about $5 below where it printed this afternoon.

I don’t rule out a brief trip back up to $90 next week as the short kill
works through the system, but in general my forecast is for the cutout
to remain in the low to mid-$80s until Christmas. The risk to that
forecast probably lies to the downside. The cash hog market is a
little more difficult for me to read at the moment. It does appear to be
stabilizing in the mid $50s, but we’ve seen that happen before only to
be followed by further downward movement. Packers are probably
not too happy with their margins at present and would like to them
closer to $40/head as they have been in the past near the end of the
year. They may not explicitly cut the kill, but they probably will take
advantage of the time around holidays to give their workforce a much
needed break and thus help prevent snugger hog supplies from
impacting margins too much in the weeks ahead.

Everyone is aware that USDA called the summer pig crop down 6%
YOY and that pig crop will start coming to slaughter next week. Over
the past four weeks swine kills have averaged 3.2% below last year,
so clearly we are not to the point where hog supplies are down 6%
yet. But it seems as though futures traders are expecting that shoe
to drop soon. They have been reluctant to press the Dec contract
below $74 and have priced in nearly a $10 increase between Dec
and Feb expirations. Someone is betting on this market turning
higher soon. Time will tell, but I tend to go with what the immediate
data is telling me and that suggests that there are sufficient hogs
available to prevent a quick run-up in the cash market. Besides, the
demand side of the pork market seems to be slowly softening and
thus we could get a moderate tightening in hog supplies without
much in the way of pork price increases. The combined margin chart
below clearly points to a demand downcycle in progress and it is
interesting that the combined margin is now approaching zero, which
is a level it hasn’t come close to in almost a year. Last year at this
time the combined margin was in a similar position and it continued
lower, bottoming around -$18 near Christmas.

Is something similar in store this year? If it is, that suggests that the
cutout will move below $80 and could test $75. That is more
pessimistic than my current forecast, but I don’t rule it out. Without
China picking up as much of the slack this year, any loss of domestic
demand will have a bigger impact on the cutout than it did last
holiday season. This week’s kill won’t tell us much due to the
holiday, but watch the following week’s slaughter closely. If it falls
back close to 2.55 million head, then that is consistent with a 6%
smaller Jun/Aug pig crop and maybe USDA’s survey is correct.
However, if it remains in the 2.6-2.65 million head range, then
possibility that the pig crop is larger than the survey indicated must
be considered.

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