Pork Wraps

The hairline cracks in pork demand started to grow a little bigger
this week. The pork cutout dropped $3.68/cwt. to average
$99.53. That is the first sub-$100 cutout since the first week of
February. As is typical, the negotiated hog market followed the
cutout lower, and the NDD market lost $2.27/cwt. All of that
hasn’t yet been reflected in the LHI, so packer margins
compressed quite a bit, now close to $6.50/head, down from $10/
head last week. Once the LHI fully incorporates the decline in
the cutout and negotiated markets, I expect that packer margins
will move back over $10/head next week. The weakness in the
cutout was largely driven by lower belly pricing, with some help
from softer ham prices. Bellies just can’t seem to get any
traction. At the end of the week the belly primal was printing
$112/cwt., which was the lowest daily value since New Year’s
Eve, 2020. I guess that is a pretty solid sign that the elevated
demand from the pandemic years is dissipating . Ham pricing
has remained very strong compared to the other parts of the
carcass, but even that has its limits apparently.

The primal printed down $1 on a weekly average basis, but bonein hams were starting to stumble near the end of the week. Even
the retail primals were looking a little shaky at times this week.
The futures market did not like any of this, and we saw the Dec
contract lose over $6/cwt this week. The more deferred issues
lost even more. All of this demand softening was happening
against the backdrop of worsening macroeconomic indicators
which fostered big losses in the stock market. That certainly
won’t help consumers to feel better, or spend more on pork. The
combined margin continued lower this week and if we look
closely at the chart, we see that prior to the pandemic years, it
wasn’t unusual for a demand downcycle to reach -$20. It looks
like that is where we may be headed again. Another sign that
demand isn’t what it used to be.

So where does the cutout go from here? Bellies are certainly
long overdue for a rally, so maybe that will materialize next week
and help lift the cutout some. Hams don’t look like they have
much gas left in the tank, so bellies or the retail primals will need
to step up if the cutout is to recover. More likely, growing
production and softer exports continue to slowly press the cutout
lower. The fundamental forecast since the end of August has
had the cutout hovering in the low $100s and then stepping down
through the $90s during October. Everything seems to be going
according to plan. I don’t think that we are going to see
widespread demand improvement across the carcass that lifts
the cutout higher.

Instead it will probably be more like whack-a-mole where one primal
pops up for a bit but that gets offset by weakness somewhere else. The
end result is a cutout that slowly fades lower under the weight of
seasonally-increasing production. The fundamental forecast has the
cutout working from near $100 today down to the mid-to-high $80s by
the end of November. This week’s slaughter came in at 2.53 million
head, which was almost dead-on with what the pig crop predicted. By
early November, kills should be running close to 2.6 million head per
week. That would be about 1.5% below last year, but keep in mind that
weights are a little heavier than last year, so actual pork production
might not be down that much. Further, softer export markets this year
compared to last and the prospect for a much stronger dollar to attract
bigger imports, raises the possibility that pork availability might be nearly
as large as last year. We got our first look at hog supplies for the Dec/
Feb quarter this week when USDA released the results of its Hogs &
Pigs survey. The Jun/Aug pig crop was reported 1.1% smaller than last
year, so we should expect slaughter during the Dec/Feb quarter to
be down a similar amount.

USDA reported the total US swine herd down 1.4% and the breeding
herd down 0.6% YOY. So the industry is still slowly contracting. If
producers didn’t expand much during the boom times of the pandemic,
there is little reason for them to expand now that the good times are
coming to an end. USDA’s survey results were only a tiny bit smaller
than what I already had dialed into my models, so the impact of the
report on my price forecasts for 2023 was minimal. Barrow and gilt
carcass weights were flat at 210 this week, but they should be up
another pound in next week’s data release. There is still nothing in the
weight data that raises concerns about producers not keeping up
with their marketing schedules.

However, because the number of market ready hogs are the
largest of the year during Q4, packer leverage increases over
producers and we should expect to see packer margins grow and
producer margins shrink. That means that if the cutout struggles,
packers have more power to push cash hog prices down in order to
compensate (more power than they would in say, the summer).
Although I fully expect packer margins to grow as we move deeper into
Q4, I think they will be a bit smaller than last year because last year
packing capacity was constrained by labor availability and this year the
labor situation is much better. That means we have more capacity
chasing fewer hogs and thus margins should be a narrower than last
year. Next week, watch for some further slippage in the cutout unless
the bellies rebound significantly. Also look for a bit of a rebound in the
futures if the fear can fade a bit and traders come to realize that they
might have overdone it to the downside this week.