Prepared by Smith Barney

Over the past four years, we have witnessed a combination of events that have set into motion an upward trend in all meat futures markets. Part of this picture is a growing global demand for U.S. meat products. In 1996, 10.3% of total U.S. meat production was exported, and the USDA is projecting that amount to increase to 11.6% in 1997. Also in 1996, 7% of total U.S. beef production was exported, and that figure is projected to rise to 8.6% in 1997. Beef exports have been on the rise from 1.6 billion pounds in 1994 to 1.8 billion in 1995 and 1996, with the USDA projecting 2.2 billion pounds in 1997. In our view, foreign demand will continue to provide an explosive catalyst to push meat prices to record highs.

Domestic consumption of beef has been fairly steady for the past several years, after sharp declines brought on by a change in consumers' attitudes about red meat in the late 1980's and early 1990's. The USDA is projecting a nearly two-pound per-capita drop in beef consumption in 1997, which we believe has more to do with tighter supplies than consumer attitudes. However, we believe this figure will be revised upward later this year. Because of a decrease in the availability of pork, retailers have been much more willing to feature beef through the first half of this year.

Regarding the beef supply picture, the major impact of high corn prices and drought in the spring of 1996 was to accelerate the 10-year cow liquidation cycle. Historical data on cow slaughter show other liquidation years in the mid- 1970's and mid-1980's, when cow slaughter as a percentage of the total slaughter was higher than the 1996-97 liquidation phase. However, the beef herd was much larger then; in fact, the total cow herd was decreased by 24% from 46 million head in 1975 to 35 million in 1996. Thus, with cow slaughter at 19.9% of the total slaughter in 1996, there should be a greater impact on beef prices than in 1975 and 1986, when the total herd was being liquidated to a level matching a decline in consumer preference for beef. Cow slaughter peaked at 28% in 1975 and 21.3% in 1986.

It is also fair to report that beef cow slaughter, at 4.067 million in 1996, was only 3,000 head less than beef cow slaughter in 1986. The 1.4% difference in total cow slaughter is accounted for by a higher dairy cow slaughter back in 1986. Eventually, a decrease in cow slaughter will lead to producers' holding heifers back for breeding.

The end result will be a sharp decrease in marketings late in 1997, and throughout most of 1998. Assuming that beef demand remains constant, we can foresee a 12-to-15% increase in cattle prices in 1998. We advise immediate purchases of December, February and June cattle futures, with objectives of $78.00, $79.00 and $78.00, respectively.

Bob Prosi

Technical Focus

Our longer-term view of this market continues to treat the 1996 low as a very significant long-term low and the starting point for a substantial long-term advance. The presence of a 5-wave movement in price from that low to the 1996 high is a confirmation of more to come on the upside, since five waves from a terminal point cannot constitute an entire rally. Since scoring the $73.95 high in September 1996, cattle prices have traded erratically, range-bound by $70.80 at the high and the $63.00 area at the lows. This has been a period of corrective activity, an assimilation of the 1996 run-up.

In a wave context, the corrective pattern is interpreted as a three-swing A-B-C pattern, which is nearing completion. Our January Outlook had a projected final swing low to the $60.45-61.60 range before renewed upside was expected to materialize. We can refine that to the $60.00-60.30 range in the immediate weeks ahead, after which prices are expected to start another advance. In a longer-term context, a weekly close over $66.42 would confirm renewed uptrend status, with the potential to ultimately trade to the $80.00 level.

As we enter the second half of 1997, lower levels are initially expected, but our overall bias on this market is bullish, and after concrete confirmation of a low in place, very bullish.

Rick Lorusso

Record highs were made last year in both live hog and pork belly futures, and we expect a repeat in 1997. These markets will be very rewarding for those traders who methodically pursue a long position. Those who argue for a bearish picture are quick to trumpet the 6% decline in per-capita pork consumption from 1995 to 1996. Further, the USDA projects a 9.6% decline in per-capita pork consumption in 1997 compared to 1996.

We have observed that retailers have chosen not to feature pork during periods of tight supply. Conversely, some of the industry's better demand markets have occurred when slaughter exceeded 360,000-to-370,00 head per day. We view the bearish argument based on domestic consumption figures to be weak at best, especially in light of the projected decrease in beef supplies throughout 1998, which will force retailers to focus more attention on their pork sales.

In 1986, total U.S. pork exports were 87 million pounds. This amount increased to 531 million by 1994, increased further to 770 million in 1995, and up to 904 million in 1996. The USDA currently projects 1997 pork exports at 1.2 billion pounds. Pork imports into the U.S. are on the decline. The net export figure for 1997 is projected at 801 million pounds. Add to the net 1997 export figure another 105 million pounds not included in the USDA's projections. This figure represents a conservative estimate of the amount of additional pork the U.S. will ship to Japan on a yearly basis, to replace a portion of the imported Taiwanese pork banned by Japan. Earlier this year, that additional export figure was estimated by the USDA to be as high as 200 million pounds, but the department recently revised that figure down by 95 million, because the Japanese have chosen to draw down their own frozen pork supplies and to import pork from Canada rather than buy U.S. pork, which carried a 24% tariff until July 1, 1997.

We still anticipate that Japan will take an aggressive buying stance regarding U.S. pork in the last half of 1997 and into 1998. At that time, U.S. hog production will no longer be running 2-to-3% under 1996 levels, but rather at par with it. The availability of additional pork supplies will also likely encourage domestic retailers to feature pork. The combination of better domestic markets and additional overseas demand could prove to be very price explosive for the October, December and February hog contracts, which are currently discounted by more than 1,000 points to the July and August futures. We prefer purchasing these distant contracts, with expectations of a rally to the $79.00, $78.00 and $77.00 levels, respectively.

Bob Prosi

Technical Focus

We have remained staunchly positive on hogs over several Outlook reports, as the price advance that began from the depressed lows in late 1994 has continued to trace out a sub-dividing 5-wave bull trend to the upside. Our January Outlook set upside objectives at $88.80, $90.80, and possibly $97.30. None of these have been realized, as the recent high was $86.60, basis the nearby spot contract. They are still valid objectives, especially as prices appear to be walking through a normal consolidation on the weekly charts.

At this juncture, while we are still anticipating that prices will move to new highs, for a six-month outlook, we must start contemplating that achievement of a new high will potentially complete the larger 5-wave sequence from the 1994 low, the 5-wave sequence from the fall 1995 low, and the smaller 5-wave sequence from the March 1997 low. As bullish as prices have been, constantly sub-dividing on the upside over the past two years, completion of all three 5-wave sequences should be followed by a significant price correction, with initial support at the $68.05 level.

We remain initially positive on hog prices into the second half of 1997, and particularly as long as the $75.50 level is not violated. On a move up exceeding the $90.17 level (the May 1996 high), we would become sensitive to any major reversal action, particularly from above the $90.80 level.

Rick Lorusso

Belly futures are retracing last year's movement, making many traders wonder whether or not this market's next step is to set new season's highs similar to last year. Recent activity has been weak, to say the least. Old highs made in April and May were left in the dust by a 2,000-point break in June. However, there have been renewed signs of life jus recently, brought on by several reasons.

For one, Japanese buyers are considering another purchase of belly meat, especially if it can be cut to their specifications or attached to the pork loin, as was their preference with Taiwanese pork. Second, fast-food chains are continuing to expand their bacon features. Bacon goes well with hamburger meat, especially when it is overcooked, as is the preference since the breakout of E-coli scares. Bacon should sell better now that school is out. Third, bacon, lettuce, tomato and club sandwiches are now in season. Fourth, and most important, the industry recognizes that belly stocks are low. In fact, as of June 13, 12-to-18-pound belly stocks were 2.0 million pounds less than during the same period last year.

Those who argue the bearish side point out that recent movement of bellies out of the freezer has been sluggish; even some bullish traders have bought the bearish argument. They have become anxious because low fresh belly prices haven't encouraged the withdrawal of frozen bellies during the month of June. We believe their concern is unnecessary. They seem to have forgotten that frozen bellies were moved out of storage in April, a very unusual event that accounts for the current low stock figure. As always, traders try to be ahead of the news and are disappointed when they do not get immediate gratification.

We believe the summer bacon demand season will come, as it usually does. We have an objective of 90.00 cents for August bellies.

Bob Prosi

Technical Focus

Based on historic precedent, prices above $1.00 in 1996 implied a decline into this year's second half. In December 1996, we expected pork bellies to trade into the high-80 cents area during January- February 1997, and then decline beyond mid-year. Instead, an extensive sideways trading range below 83.000 prevailed into April. At that point, price activity turned vertical–an aggressive rally reached 95.20 cents before stalling.

Failure of this market to conform to historic cyclical precedent in 1997 raises the possibility that the character of the market has changed. Prices may be in a new and higher trading range than has prevailed during the past 30 years. However, our technical perspective on this market is not yet ready to accommodate that prospect.

The weekly “island” reversal made in 1996 still stands, and therefore still implies a major trend top. In addition, the 3-swing rally (ABC) from the October 1996 low established a high in April that was unsuccessfully “tested” in May subsequent price weakness features a return to the December-March trading range. Generally in an ABC-type move, a return into the B-swing area implies that the overall structure is a non-trending, or corrective, phase.

Thus, we conclude that pork bellies may be in an extended cyclical decline that will bottom beyond our original time-frame expectations. Chart appearance and a recent downturn in the stochastic indicator suggest that the market could be on the verge of the second down phase in the cycle. Confirmation of that would be a weekly close below trend line T, currently in the 76.50- cent area. If that occurs, lower prices should prevail in the third and fourth quarters. Target potential would be 55 cents. If prices fail to break below the trend line, then we would be forced to reconsider the possibility that a higher-level trading range has been established.

Jim Nason

July 1997 David Rinehimer, Director of Futures Research

Smith Barney

390 Greenwich Street, 1st Floor, New York, New York

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