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IRA EPSTEIN & COMPANY
223 West Jackson, 7th Floor, Chicago, Illinois
(August 13, 1997) HOGS: Lean hog futures, which trade at the Chicago Mercantile Exchange (CME), have taken a significant beating within the past week and may be indicating the beginning stages of a long-term market top. Specifically, the October contract has declined four cents, or over five percent in value from its peak price which was near 76 cents achieved in the month of May.
For weeks the market has been supported by tight hog supplies and increasing export demand. Specifically, a portion of Japanese pork demand diverted to the U.S. from Taiwan due to an outbreak of hoof-and-mouth disease which received large notoriety several months ago.
Last week, however, this support dissolved rapidly as market participants began to turn their attention away from current hog supplies toward a seasonal increase in hog numbers, which often occurs between now and the month of October. This increase in numbers has coincided with a sharp decline in cash hog values.
Additionally, I believe traders have begun to realize that a five percent reduction in the Japanese import tariff for the month of August will have little impact on overall demand or prices. In summary, the Japanese will only receive meat during August which has already been shipped. Any business done during August will arrive after the tariff reduction expires. Therefore, little additional business is being booked at this time.
Technically speaking, some are arguing that the market is and will remain in a near-term bull move, with an eventual objective near eighty cents. I on the other hand, feel the market has achieved a long-term peak and will settle within a short-term, six- to seven-cent trading range.
It is my belief that the stochastics, a measure of market momentum, are indicating weakness through a common event known as divergence. Divergence occurs when a commodity price reaches a new high, as it did in the October hog futures from July to August. While this occurred, the momentum indicator failed to do the same.
A second argument for bearish traders may be a failed Elliott Wave formation. Elliott Wave is a study utilized by traders which in its simplest terms states that markets move in a series of either three or five waves. In this instance, I believe very small first and second waves were witnessed in the beginning of March; a large third wave was evident from the end of March through the beginning of May; a forth corrective wave extended from mid-May through mid-June; and the final fifth wave seemed to fail last week near resistance at contract highs.
Divergence, combined with an apparent failure at prior contract highs, leads me to believe the market has peaked. However, I believe boundaries will remain near the highs at 76 cents and the lows achieved in the month of June near 69 to 70 cents.
I do not believe the lower boundary is arbitrary. Rather, it is based on fundamental as well as technical factors. First, the October futures are already trading at a 7- to 8-cent discount to the current Lean Hog Index. A normal 10- to 11-cent seasonal decline would translate into a 69- to 70-cent October hog future. Second, previous low points such as the 69- to 70-cent lows in the month of June often provide future support. I expect this rule to hold true once again.
Keep in mind, however, that volatility often increases at market turning points as bullish and bearish inputs clash with one another. Although I believe contract highs may be in place, this does not mean the market will move dramatically lower. Instead, long and short positions may be warranted as the market revolves within the previously mentioned range.
Mike Peifer
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