steve-meyer
Steve Meyer is an Economist for Kerns and Associates.

By Steve Meyer

Two years ago in this column, I warned producers that things could get rough in the fall and that they should focus on price protection as supplies grew. Spot prices indeed did fall to the lowest level in a decade.

And here we are again, with carcass prices in the low $40s. Packing capacity is not nearly as short as in fall of 2016, but numbers are such that, even with today’s expanded capacity, packers are not working hard to secure pigs. Let’s look at key factors as we go into the fourth quarter and 2019 with ample supplies.

 

Trade Relationships, Exports and African Swine Fever

The three topics are closely interrelated, with uncertainty about all of them. The trade war has resulted in significant tariffs placed on U.S. pork by two major markets: China and Mexico. As of mid-August, Chinese tariffs added up to 78 percent, and Mexico is imposing 20 percent on U.S. hams and shoulders. The Chinese tariffs had little impact through June but reportedly resulted in almost zero product moving to China since early July. Product that is moving is running into arbitrary restrictions that are keeping it out even if a buyer is willing to pay the tariff. An example: An inspector judged a mid-August load of “long” pig feet as too short to be “long” and thus rejected the shipment.

Mexico still is buying U.S. hams, but has been able to deduct a high portion of the tariff from the purchase price. This was expected because Mexican processors need fresh U.S. hams and are almost certainly not willing to invest in thawing facilities over what still appears to be a short-term trade spat. Rumors of a handshake deal with Mexico are swirling as of this writing, and a solution would be a shot in the arm for U.S. pork markets.

Mixed factors will be at play in the fourth quarter, with market pig numbers expected to be up 4 percent from a year ago

The latest data show total U.S. pork and pork product exports were up 1.3 percent, year-on-year, in June, with year-to-date exports up over 6 percent as through the first six months. The increases are likely to get smaller later this year, but exports are still good. Efforts such as the Pork Checkoff increasing efforts to grow exports in other markets are helping.

And that brings us to African swine fever (ASF) in China. As of this writing, multiple cases had been confirmed, resulting in tens of thousands animals culled. Some of the infected animals were transported through hog-dense areas.

How big could this be? Huge. All of the pork traded between nations in the world equals only about 15 percent of Chinese consumption. The virulence of ASF, the density of pigs in China and the lack of biosecurity on many Chinese farms suggest that the disease will be difficult to control there. According to USDA, there were more than 433 million pigs in China at the beginning of 2018. A loss of 10 percent would equal more than half of the 73 million pigs in the U.S. on June 1.

If China suffers large ASF losses, the U.S. could benefit even if not shipping product there. If tariffs remain in place, increased Chinese purchases from the EU or Canada would reduce their exports to Japan and Korea, opening opportunities for U.S. pork in those countries. Of course, ASF would have a huge negative impact if it reached the United States.

 

Domestic Demand Remains Strong

Consumer pork demand is still strong. In June, real per capita expenditures (RPCE) for pork were down 1.9 percent from a year ago, but RPCE year-to-date was up 0.5 percent. Demand for other species was down slightly through June, but nothing suggests that either meat or pork demand are soft. Retail meat prices remain strong even with higher production and per-capita offerings. The strong economy bodes well for meat demand at least into 2019.

 

Hog and Pork Supplies Are Ample and Growing

USDA’s June Hogs and Pigs Report indicates large hog supplies this fall and well into 2019. The surprise of the breeding herd being up 3.5 percent, year-on-year, on June 1 suggested even further growth in the second half of 2019. USDA estimates 2018 pork production to be up 4.4 percent from last year and up another 4.6 percent in 2019. Even with exports expected to grow 6 percent this year and 5 percent in 2019, USDA estimates 2018 per capita availability/disappearance/consumption at 51.7 lbs. (up 3.2 percent) and 53.9 lbs. in 2019 (up 4.3 percent). If accurate, 2019’s level will be the highest since 1980.

Summer slaughter was variable, but on the whole close to levels predicted by the June report. In July, Smithfield Foods closed several plants for three days to install a new software system. Though the plants worked extra hours the week before and following the installation, the closures, as well as some suspended shifts at other plants, delayed the marketing of about 200,000 hogs. This caused weights to jump sharply in late July, but they dropped back near year-earlier levels within a few weeks.

Fall slaughter should exceed 2.5 million per week beginning mid-September and 2.6 million per week late October. Fourth-quarter slaughter should exceed year-ago levels by 4 percent. Pork production will likely be up 4.5 percent from 2017.

 

Surprising Summer Price Pressure Signals a Difficult Fall

The cutout value and hog prices have been under pressure since late June and under intense pressure since mid-July. Virtually every piece of market information was negative until the news of ASF came in early August. Cash markets remained under pressure but Lean Hogs futures got a short-term boost with nearby contracts seeing a short-lived gain of about $10/cwt while summer 2019 contracts rose $6 to $8/cwt. The problem, of course, is that fall contracts gave up much of that gain quickly and remain at levels that will not cover costs of production for most producers. Next year’s contracts are priced at levels that will roughly break even for the year given this year’s apparently good corn and soybean crops.

The situation cries for playing defense on pricing except for the possible explosive impact of China’s ASF situation. That means establishing price floors where possible and cost-effective while leaving the top side of the market open in case China is forced to chase world pork supplies. Put options accomplish both. Your broker or advisor can provide strategies to manage the cost of those options.

It is absolutely critical to know your financial position and how much risk it allows you to take on. Assess your personal preferences and risk tolerance. Involve your banker and other advisors to map a plan to navigate these difficult times.

So here we are. The answers may not be the same, but the process is familiar. It’s time to get to work. Again.