by Steve Meyer, economist, Kerns and Associates
Dickens began A Tale of Two Cities with the famous line, “It was the best of times. It was the worst of times.” While not a perfect description of recent pork production economics, there currently is a dichotomy.
On one hand, cash hog prices have held up well (as of May 22) since a big March rally, gaining about $4/cwt mid-April to mid-May. On the other hand, lean hog futures have been pressured roughly $10/cwt lower for summer months and $8/cwt for fall.
How has this impacted actual and expected profitability? Things still look very good for producers for the remainder of 2019.
First, production costs continue to moderate as grain prices struggle. As of mid-May, the corn market was bullish as wet conditions kept planting progress well below the normal.
But the world is awash in soybeans, and the Chinese still are not buying U.S. beans. Together, those factors put projected average costs at $62.55/cwt carcass in our model, which is based on Iowa State University’s historic costs estimates.
That number is in line with the past three years. It represents, I think, the best 20 to 25% of producers. But the average would be the upper $60s, and the lowest lean hog futures contract on the board May 22 was for October 2020 at $80.90.
Second, futures prices are lower than they were mid-April but are still extremely high on a historical basis and unusually constant through mid-2020.
The reduction in summer 2019 contracts certainly suggests profits may not be as large, but having futures near $90 next summer provides opportunities for long-term profits.
These futures prices are more than a bunch of gamblers betting on futures prices in Chicago. These are real price offers at which producers can price future corn and soybean meal purchases and can price hogs to be sold in the future.
Pricing from futures is not perfect. Basis (the difference between cash and futures prices) can vary over time and impact the net realized price. But variation in basis is almost always far smaller than variation in the prices. That means less price risk.
The same goals can be realized with options. The level of market volatility in recent months has caused options premiums to grow, leaving some options strategies relatively costly.
Regardless of what method you choose for pricing and price-risk management, involve your bankers from the onset. They need to know what you are doing and, if you are using straight futures or shorting any options, you must have a credit line to cover margin calls.
As of May 22, future revenue doesn’t look as good as a month ago. But it’s still excellent relative to history. It could get better if the trade issue with China is resolved, or much worse if African swine fever finds its way to our borders.
But when did you last average over $40/head profit for a 12-month period, which was roughly available to average producers as of May 22. It wouldn’t make for a bad year, would it?