wmeubank@ocp.kcmo.com
BARNES BROKERAGE CO., INC.
30 S. Wacker, Chicago, Illinois
(November 5, 1997) LIVE CATTLE: “VIEW FROM THE PIT”–At this writing the most appropriate word I can think of to best describe the cattle markets (live and futures) would be “frustrating.” We finished last week with most cattle having traded at $70.00. Although the overall volume should be called moderate the general consensus appeared that all major cattle areas sold more than their showlists and we were beginning this week again with an extremely current feedlot status. As usual, this situation caused us to begin this week with producers asking $71.00 to $73.00 while packers began the week bidding $67.00 to $68.00. As of this afternoon (Wednesday) we remain in the stand-off position except the bid prices have gone to a solid $68.00 with no takers, while offers have been reduced to $69.00. By the time you receive this letter we will all know at which of these prices the trade actually developed. I find it interesting to note that one of the major packers last week was conspicuous by their absence in the open market. This packer still has not come to the table as of today. Instead they appear to be pulling formula and contract cattle forward with the strategy that we will see larger numbers a few weeks farther down the road. In my opinion, what we are again seeing is another example of the tremendous power we have handed to the packers by granting them formula and contract cattle. Of course you could choose to believe the leaders of most of our associations that continue to claim that captive supply does not really affect our cash market.
The bear arguments at this time are popular and have substance. They appear to be mainly two-fold. (1) Coming weakness in beef. (2) Heavy July and August placements creating a substantial increase in finished cattle numbers over the next few months. My response to this is: (1) Today's boxed beef price for lightweight choice boxes is $105.13 which is only $.82 under last week. This is the first week of November and chain stores are now buying for Thanksgiving. I expect to see a substantial near-term increase in beef futures immediately following the holiday. I also remain very optimistic regarding beef exports. Per the USDA World Markets and Trade report released October 31, “Beef exports in 1997 increased only 2% over 1996 mainly because of slowed demand as a result of negative food safety publicity. However in 1998 the USDA expects these concerns to subside thus allowing demand to grow freely again. USDA is presently forecasting 1998 beef exports of 950,000 tonnes compared to 870,000 tonnes in 1997.” That represents an increase of over 9% fueled mainly by heavy increases of beef exports forecast to Mexico. (2) It is true that July and August placements were heavy, however I think it is also necessary to note that during these two months the total placements of cattle weighing over 800 pounds were over 28% above the prior year. That means that the majority of these placements were heavy yearlings and will certainly be dead before the end of the year. I further believe that we are continuing to pull a great many of these cattle forward which will add to the anticipated tightness in a very short time. I also expect the next Cattle on Feed report to show sharply lower placements which is a pattern I expect to see continue for the next year.
An additional factor that adds to the confusion of opinions at this time appears to be lack of differentiation between today's live cash cattle market and the December futures. For example: Yesterday, as I returned to my office from the trading floor, one of my cohorts asked me if I thought the cattle market had seen its high for the rest of this year. My response was–“Do you mean cash or futures?” While to some people, this difference may seem obvious, to the majority of the industry, this difference requires a clear clarification. For the past 2 years plus we have seen each of these futures contracts maintain an average premium of about $1.50 over the cash market. (The industry refers to this as a positive basis–futures over cash.) This basis was higher in early and mid-1996 due to the fact that the $5.00 plus corn market created a majority of short-fed cattle that graded poorly. Because the futures contract calls for 55% choice cattle with a sizeable discount for too many “select grades” and a severe penalty for “sub- select” we saw the futures maintain a plus $2.00 to $3.00 premium over the cash market. This was justified because of the poor grading of many of these cattle and I believe we will see a similar circumstance for December. I continue to hear stories about the severe damage done to those cattle by the recent weather and how a substantial portion of them will never fully recover. According to most recent reports, I believe cattle are now averaging under 45% choice. Note the difference in the boxed beef, choice versus select. Today's difference is $9.94 compared to a difference of $3.64 in 1996. I expect to see December futures maintain a $2.00 premium over cash cattle. That means that while I believe we could see the cash cattle market retrace to $66.00 to $68.00, the December futures at that time would still belong trading between $68.00 and $70.00.
In last week's letter I recommended buying both December and February futures on any further weakness buy my preference at that time was definitely for February. December closed today at $66.75 which is exactly the same price s last week. My preference continues to be in February which retraced to $67.75 before closing today at $68.92. I continue to expect to see both of these futures contracts eventually trade $1200.00 to $1500.00 per contract higher before they go off the boards.
Due to the funds liquidating of positions we have rolled most of our December long positions into February leaving the bulk of our spread positions as long February-short June. This spread closed today with February —110 under June. I continue to believe that this trade offers the best profit potential in the cattle futures today. The average over the past 10 years shows February finishing at +4.50 over June. In 1993, February futures traded as high as $9.50 over June. My initial target on these spreads is +200 which represents over $1200.00 per spread on a margin requirement of $350.00 each.
Futures anticipate changes in cash cattle and beef and this creates volatility and opportunity. You must stay in contact to recognize the difference between a reversal and an “entry opportunity.” Say current. Keep selling cash cattle on the open market.
Les Messinger
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