Overview
From Barchart
“Hogs are generally bred twice a year in a continuous cycle designed to provide a steady flow of production. The gestation period for hogs is 3-1/2 months and the average litter size is 9 pigs. The pigs are weaned at 3-4 weeks of age. The pigs are then fed to maximize weight gain. The feed consists primarily of grains such as corn, barley, milo, oats, and wheat. Protein is added from oilseed meals. Hogs typically gain 3.1 pounds per pound of feed. The time from birth to slaughter is typically 6 months. Hogs are ready for slaughter at about 254 pounds, producing a dressed carcass weight of around 190 pounds and an average 88.6 pounds of lean meat. The lean meat consists of 21% ham, 20% loin, 14% belly, 3% spareribs, 7% Boston butt roast and blade steaks, and 10% picnic, with the remaining 25% going into jowl, lean trim, fat, miscellaneous cuts, and trimmings. Futures on lean hogs are traded at the CME Group. The futures contract is settled in cash based on the CME Lean Hog Index price, meaning that no physical delivery of hogs occurs. The CME Lean Hog Index is based on the 2-day average net price of slaughtered hogs at the average lean percentage level.”
From TheBalance
“Most hog production occurs in the Midwest. The largest hog producing states are Iowa, North Carolina, Minnesota, and Illinois. The U.S. is the world's largest pork exporter. Normally, it takes six months to raise a pig from birth to slaughter. Hogs are generally ready for market/slaughter when they reach a weight near 250 pounds.
A market hog with a live weight of 250 pounds will typically yield 88.6 pounds of lean meat (Pork Facts 2001). This lean meat consists of an average of 21 percent ham, 20.3 percent loin, 13.9 percent belly, 3 percent spareribs, 7.3 percent Boston butt roast and blade steaks, and 10.3 percent picnic. The rest goes into jowl, lean trim, fat and miscellaneous cuts and trimmings (USDA-AMS). Pork bellies, which used to trade on the CME, are mainly used for bacon and can be frozen and stored for up to a year prior to processing. The contract was discontinued due to a lack of liquidity. Tips on Trading Lean Hog Futures: Seasonality tends to lead hog prices higher between May and July the heart of grilling season in the United States.
The price of corn has a strong correlation with lean hog futures because hogs eat corn. If the price of corn rises substantially, farmers tend to take their hogs to market at lower weights (younger) to avoid high feed costs. At these times, lean hog futures prices tend to drop due to increased supplies. One can estimate the future amount of hog production by monitoring the Hogs and Pigs Report. When the number of newborn pigs is lower than in previous quarters, it is likely that hog production will be lower in six months later when they are ready for market.”
The Lean Hog (cash) Index or LHI
As stated above, the Lean Hog futures contract is financially settled and uses the CME's 2 day weighted average cash index to determine the final price. The details of the index can be found here.
Note that the cash index is related to the cash that is paid for live hogs and not for the finished pork product.
The data the index uses are released in report "LM_HG201" which details prior day production for US hogs. This report is issued every weekday morning around 10am central and allows you to calculate the CME index before they publish it since they typically lag 2 days in their reporting. Calculation. Note that the report isn’t released at any specific time as I’ve seen it range from 10:30am to 11:30am (and sometimes not until after the market closes on the days where the contract settles due to “packer submission issues”….)
For a quick overview, these cash prices are what packing plants (e.g. Tyson) are paying to Hog producers for their livestock. Another important data point is the cutout value which indicates what packers are able to sell their products for. We can determine their margins based on the values they're paying for hogs and the values they can sell the end product for. From here we can get a glimpse at future action depending on a few other variables most notably demand (consumer spending, international trade relationships, global demand for protein, seasonality etc.)
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Cutout AM released around 11am central
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Cutout PM released around 3pm central and these are the final daily prices.
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Hog Daily Summary released shortly after the PM report
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Here’s a link that provides a bit more detail on the various reports & pricing methodologies
The important thing to note is that the future price and cash index will converge at the end of every contract's life. This isn't always the case in physically delivered contracts but it is in the financially settled ones. It is worth noting that it won’t be an exact convergence but rather an educated estimate so there is some arbitrage opportunity here but the market is fairly efficient so it’s very hard to get an edge.
Contract Specifications
• Ticker Symbol: LH
• Exchange: CME
• Trading Hours: 9:30 a.m. to 2:05 PM EST.
• Contract Size: 40,000 pounds.
• Contract Months: Feb, Apr, May, Jun, Jul, Aug, Oct, and Dec.
• Price Quote: price per pound. Ex $.5950 per pound or 59 and 1/2 cents
• Tick Size: $0.00025 or 2.5 cents per pound = $10.00 (0.00025 x 40,000 lbs).
• Last Trading Day: The tenth business day of the contract month.
October Contract
Here is what the October contract looks like today
Currently there's a $2.85 positive spread between the futures price of $51.78 (8.24.18) and the latest CME index of $48.93 (8.23.18). The October contract began its descent on June 28th when the quarterly Hogs and Pigs report was released (Link). This report showed that the total hog inventory was up 3%, which was the highest June 1st inventory measured since it was first measured starting back in 1964. The breeding inventory was up 3% YoY, the marketing inventory was up 3% YoY, and the March-May 2018 pig crop was up 4% YoY. The report showed that hog production from mid-July through November would be, on average, 3.7% higher YoY which was higher than the trade had been expecting. It also showed that the breeding herd increased by 3.5% YoY which is much higher than the trade’s estimate at +1.7% YoY. Long story short, this report showed that production in the second half of 2018 would be record large and that the growth of the herd was still strong and not expected to slow in the near term.
What has happened since then is that packers have broken the cash (I’m referencing the LHI) down from a June 22nd peak of $86.20 to the latest index price of $48.93 on August 23rd (Link to the August contract shows how much of a break in pricing this was ). The break in the cash was intensified by producers pulling forward inventory to take advantage of higher cash pricing in Q3 than what they feared they would have to take in Q4 which could be seen with the implied pricing given by the December contract ( Shown Here ).
The week of August 15th brought a significant rally in futures pricing due to a combination of a potential NAFTA breakthrough and initial ASF (African Swine Flu, which I’ll get into later) which was largely driven by short covering. These gains in the October contract have mostly been given back as NAFTA did not come along as quickly as hoped, cash pricing continued to decline and reality set back in.
Current futures curve of the hog market
2019 and Potential Supply Disruptions
As mentioned above, domestic pork production in the United States will remain at high levels until the herd begins to experience a contraction. Going off the assumption that any contraction will not be likely to occur until at least 2019, one can infer that prices will very likely remain at depressed levels for the near term. However, there are a couple factors that could begin to change up the S&D picture for 2019.
1) Trade resolutions that increase demand for exports
Earlier this year, Mexico put into a place a series of tariffs that were designed as a way of striking back against the United States for its steel & aluminum tariffs. Since Mexico is the largest single international buyer of pork, there were specific tariffs placed upon pork (only the most popular cuts) and it’s very important to note that there was a 350K ton allowance before these duties are implemented. The result of these tariffs was enough to drive the cutout pricing lower which actually increased demand for pork outside of Mexico as shown on the chart below:
Weekly pork export sales per Allendale
It’s difficult to determine how much of an effect a NAFTA resolution could actually have on cash prices and may end up being more psychological than anything. It could however drive buyers back to the market with the assumption being that they would want to start purchasing cheap product while they can.
2) Diseases that shrink the supply
Earlier this month, African Swine Fever (ASF) was discovered in China for the first time and since then there have been a total of 4 outbreaks spread across a wide geographical distance. This article from “Sciencemag” does a great job in describing the virus and some of the implications.
USDA special report on African Swine Fever in China
Bloomberg – “ASF could impact US-China trade talks”
It isn’t possible to predict with any certainty how the disease will spread -— there could be sporadic outbreaks with an insignificant national effect. But the density of hogs and the scale at which they are raised in China creates a serious risk, Stuart said. A widespread outbreak could lead to mass culling of hogs, and since imports represent about 3 percent of China’s pork consumption, even a 10 percent cull would have significant impacts on import needs.
"It’s not like they need the U.S.," Stuart says, noting that the European Union is a bigger exporter, supplying about 55 percent of the Chinese market, so the potential impact from the disease on trade talks wouldn’t be immediate. "But when you look at potential, it could get to a scenario where they consider lifting the duties."
The best case scenario for China is that the disease doesn’t spread beyond these current outbreaks and the losses remain relatively minimal. The worst case is the Chinese can’t contain the virus and it begins to spread in such a way that they are forced to cull massive numbers of hogs. Should this happen, its possible China will have to turn to foreign importers to replace the lost supply which could be the EU given their already sizable export program and China’s current trade issues with the US. However, it’s probably worth mentioning that Romania just had a large outbreak of ASF ( Reuters Link ) within their largest pig breeding farm that will result in the culling of 140K animals. It seems as though there were outbreaks on smaller farms in the region and those farmers ended up tossing the dead carcasses in the Danube River which this larger commercial farm uses for drinking water.
By itself, the outbreak in Romania is probably not an issue worth concern but it’s worth keeping an eye on in case this spreads to somewhere like Germany which rivals the US in terms of export value (both export 15% of the global value). This would be the worst case scenario and probably unlikely due to the health & animal welfare standards in Western Europe (example: Denmark is actually building a fence to keep wild boars out of its borders). Overall, it’s worth keeping an eye on but it will be a non-issue if they contain it.
Prior Examples
Chinese Government’s handling of SARS
- Great example of how transparent the Chinese government can be (hint: not very).
Chinese PRRS outbreaks in 2007
- In 2006 & 2007, PRRS broke out across China resulting in domestic Chinese pork prices increasing as much a 4x in some provinces and driving Chinese inflation levels to multi-year highs.
World Trade at a glance:
Submitted August 27, 2018 at 09:43PM by Lost_in_Adeles_Rolls https://ift.tt/2MUEME5
