wmeubank@ocp.kcmo.com
BARNES BROKERAGE CO., INC.
30 S. Wacker, Chicago, Illinois
(November 12, 1997) LIVE CATTLE: “VIEW FROM THE PIT”–We began this week as a carbon copy of the beginning of last week. If you remember, last week saw virtually no trade for the first 3 days of the week. As of my writing of this letter (Wednesday afternoon) we had seen almost no trade at all on the open market. Producers passed on $68.00 bids even though the industry pipelines were filled with talk about how many cattle packers were getting bought at $68.00. I am happy to say that this time the producers did not take the hook, stood his ground, and Thursday we saw a very active trade develop at $69.00. The fact that packers ran the candle all the way to the end became extremely obvious when we saw the amount of cattle that packers bought on Thursday and picked up on Friday. Again, the bulk of the trade was finished in about an hour, but when the smoke cleared we saw showlists completely sold. We began this week with packers again claiming that they were bought through the end of the week, cattle were losing money, and boxed beef was going into the sewer. Packer bids were $66.00 and $67.00 with producer offers at $69.00 and $70.00. Add to this equation the private information that packers let be known about how they had enough contract and formula cattle to carry them through the holidays.
This was the situation coming into today (Wednesday). About 11:00 A.M. word spread across the trading floor that several packers were to $68.00 bids but were still having trouble buying cattle. December futures immediately responded by rallying 70 cents from $66.50 to $67.20. As the trade continued, it became know that they were getting cattle bought at $68.00 and the futures settled back a little. In my opinion, packers remained close bought and would have readily paid $69.00 for cattle if producers had acted in the same manner as the previous week.
A major portion of the bear argument at this time hinges on the opinions that we cannot move the beef. I do not agree with this. During the first and second week of November we normally see a little weakness in beef demand due to retailers gearing up for Thanksgiving. Today's price on lightweight choice boxed beef if $104.94, a scant $.19 under last week's price on pretty decent volume. If it were true that packers are losing money, or that beef demand was poor, we would see packers reducing the cattle slaughter. Yesterday was a partial holiday (veterans Day) and slaughter for the first 3 days of this week is 377,000 head versus 369,000 last year. Another large part of the bear argument is that feedlots are full, and the heavy July, August, and September placements were lighter weight cattle that were either set back by the storm, or weren't really scheduled to finish before February. My response to that is that feedlots are always full at this time of year and if we continue to place substantially less cattle on feed and market substantially more cattle out of the feedlots, we will go through these numbers very quickly. (See Cattle-On-Feed report on November 14). I also do not agree that many of the 3rd quarter placements were lighter weight cattle. Per the USDA 7-State Cattle-On-Feed reports, July placements of cattle over 800 pounds were 143% of 1996, August placements over 800 pounds were 119% over 1996, and September placements over 800 pounds were 108% over 1996. These numbers show heavier cattle going into the feedlots and bear out my argument that the bulk of the feedlot population were scheduled to be finished before mid-January and I believe our extremely aggressive marketings have pulled many of these cattle forward. Also, regardless of what they say, I believe our extremely aggressive marketings have pulled many of these cattle forward. Also, regardless of what they say, I believe packers have pulled much of their captive supply early trying to keep a lid on this market.
In last week's letter, I talked about my being bullish December futures because at the present time the futures are trading at a substantial discount to cash while I believe that when we get into December we will see the futures trade at a $2.00 premium to cash. This bears addressing a second time. For the past 2 years plus we have seen the futures contracts maintain an average premium of about $1.50 over the cash cattle market. (A positive basis). During early to mid 1996 this positive basis moved to about $3.00 because the $5.00 plus corn market caused feeders to market cattle early, creating a higher percentage of select and sub select than the futures contract allows (futures require 55% choice for delivery). I am now told that because of the recent weather, cattle are now grading on average under 45% choice. This means that futures belong trading at a minimum of $2.00 premium to the cash market. I also believe that the current futures market discount to cash creates an extremely healthy situation where all producers with cattle hedged in December have a tremendous incentive to market cattle early and buy in their hedges at an extra $18.00 to $24.00 per head profit that they did not anticipate. In addition to this, the discount in the futures provides strong encouragement to all producers to market cattle as aggressively as possible.
December and February futures closed today at $66.80 and $68.67 which is very close to the same price they were at last week. Although I agree that we have abundant numbers of cattle on feed at present, the continuation of strong domestic demand, increased export demand, coupled with the aggressive marketing of cattle should allow our cash cattle market to remain in the $65.00 to $68.00 area for the rest of the year. This should allow December futures to trade in a range of $67.00 to $70.00. In last week's letter I recommended buying both December and February futures but I also indicated that at that time my preference was towards February. My reason for this was that I wanted to escape the pressure on December that occurs during the month prior when several funds always sell out their long positions. This has happened and I now believe the remaining majority of funds are short the futures and will soon be buying their positions back. For this reason, although I also remain long February futures, my preference is to buy December futures anywhere near today's trading range for an eventual move upwards of $800.00 to $1200.00 per contract.
My main spread positions remain long December and February futures and short June futures. The kindest way of describing these spreads would be to liken them to the Chinese water torture. Nonetheless I continue to believe that both of these spreads offer some of the highest potential profits per investment that we will see for a long time. December traded today at —370 under June while February made a new contract low at —175 under June. The margin requirement on these spreads is $350.00 and my initial profit objective on both of these spreads is $1200.00 to $1500.00 per spread. The average spread difference over the past 10 years shows February finishing at +4.50 over June.
Changes in live cattle and wholesale beef will trigger changes in the futures. Knowledge of pit activity is necessary for proper entry into these positions. You cannot trade off a market letter that is almost a week old when you receive it. Stay in contact. Stay current. Keep selling cash cattle on the open market.
Les Messinger
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