Live Stock and Meat
Futures
| Live
Cattle | Feeder Cattle | Lean
Hogs | Pork Bellies |
This article is reprinted from the Livestock Trader's Almanac
The United States is the largest producer of high
quality grain fed beef in the world. With
an abundance of pasture land suitable for grazing and large supplies of feed
grains, the United States is one of the only countries in the world which has a
cattle industry largely separate from its dairy industry.
 Cattle
production is a long and involved process with two major production sectors:
Cow-Calf operations and Feedlots. Cow-calf
operations are in the business of reproducing cattle.
The finished product of a cow-calf operation is feeder cattle, or a
weaned animal weighing between 600 and 800 pounds, ready to go on feed. Cow-calf operations usually sell their cattle crop to
feedlots, who are in the business of producing high quality beef cattle –
grading select or better – by fattening them with grain and protein
concentrates. Depending upon the
weight of the animal at placement in the feedlot, feeding conditions, and
desired finished weight, the feeding period can last from 90 days to 300 days,
though it tends to average about 140 days.
Feedlots sell their production to meat packers,
who slaughter the animals and package them into the cuts of meat we all enjoy.
Though in recent years, the industry has tended to shift towards a small
number of very specialized feedlots, which are increasingly vertically
integrated with cow-calf operations and processing sectors to produce high
quality fed beef.
The activity of packers is partially set public
tastes as well as supply from feedlots. Feedlots
base their production on demand from packers, as well as supply availability
from cow-calf operations. Both the
feedlot and the processor have some degree of flexibility in their operations,
able to move inventory and change output. At
the beginning stage of the production cycle, the cow-calf operation has a very
long lead-time in adjusting its operations.
In order for a calf-calf operation to increase
its production, it must retain animals for breeding purposes.
This would require a calf-calf operation to retain more heifers from its
marketing, which in turn reduces the cash flow to the operation and reduces the
supply of cattle on feed. The retained heifer would be bred several months
later, with the additional calf crop not marketed until the following year.
If a cow-calf operation wishes to reduce its production capacity, it only
needs to sell some of its breeding stock, generating immediate cash flow, but
decreasing future productivity for a minimum of at least 2 ½ years. Because of the long lead-time necessary to increase capacity,
cow-calf operations tend to be very leery to sell breeding stock and tend to
maintain fairly regular herd sizes.
Cow-calf operations are businesses, and like any
other business the goal is profit. During
times of profitability, cow-calf operations try to expand by increasing breeding
stock. This has the short-term
effect of reducing the supply of feeder weight cattle, which in turn tends to
support prices. The feedlots pay
higher prices for the cattle, which in turn raises the price processors pay, and
eventually the price the consumer pays. Eventually,
however the price becomes high enough to the consumer that they begin to eat
other substitutable meats (pork, poultry, fish).
Packers begin to incur losses, and reduce operations.
The lack of demand from processors causes feedlots to decrease the number
of animals they are willing to feed, which in turn reduces the price they are
willing to pay for feeder weight cattle. Cow-calf
operations, faced with losses, sell off breeding stock, further decreasing
prices as supply increases. Eventually, the flood of supply from herd
liquidation stops, and the available supply is below the current demand at these
depressed prices. Cow-calf
operations begin retaining heifers for breeding purposes, supply shrinks even
more, and prices increase as the whole process begins again.
This boom to bust cycle in herd sizes is known as
the Cattle Cycle. The Cattle Cycle
refers to the increase and decrease in herd size over time. This cycle usually last between 8 and 12 years, as the time
it takes to adjust herd sizes to changes in pricing is long.
The typical Cattle cycle takes about ten years from low production and
profitability to another trough. The
herd building process typically takes between six and seven years, while herd
liquidation phase usually takes between three and four years.
The Cattle cycle has had historic peaks in 1935, 1945, 1955, 1965, 1975,
1982, and 1996. The last cycle
topped out in 1996 with slaughter the Cattle and Calf population at 103.5
million head.
 The
Cattle cycle is typically measured from trough to trough (bottom to bottom) and
as such, the current cycle began in 1991. In
1991, the United States Cattle and Calf population stood at 96.3 million head
and grew to 103.8 million head in 1996. Currently
the Cattle cycle is officially in its 5th year of contraction.
The last Cattle cycle from 1980 to 1990, peaked in 1982 and had 8 years
of contraction and only two years of expansion.
At the peak of the 1980 to 1990 cycle, Choice 2-4 Texas 1,100 to 1,300 lb
slaughter steers averaged $65.94/cwt in
1982. By the 5th year of
the herd contraction in 1987, Choice 2-4 Texas 1,100 to 1,300 lb slaughter
steers averaged $66.63/cwt and by the end of the cycle in 1990, they averaged
$78.73/cwt, an increase of $12.79/cwt or 19%.
During the contraction phase of the last cycle,
the number of Cattle on Feed increased roughly 70% as breeding stock and more
heifers were introduced to the slaughter mix.
As is often the case, during the contraction
phase – about half way – Cattle prices began to take off.
Choice 2-4 Texas 1,100 to 1,300 lb slaughter steers bottomed in 1986
below $60/cwt and rallied to almost $80/cwt as cattle inventories dropped.
The current cattle cycle began in 1991, as herd
expansion began to take hold. In
1991, 577 thousand head were added to the population in the January 1st
census. In 1992 and 1993, herd
expansion was in full force adding 1,163 and 1,620 thousand head, respectively.
By the spring of 1993, the increased number of cattle began to weigh on
prices, with prices topping out at $82.66 hundredweight – basis Choice 2-4
Texas 1,100 to 1,300 lb slaughter steers. The
increase in production from 3 years of herd expansion had taken its toll on
prices.
 From
the spring of 1993 until September 1998, Choice 2-4 Texas 1,100 to 1,300 lb
slaughter steer prices declined, dropping from $82.66 to $57.93 per hundred
pounds.
The current cycle, which is in its 11th
year, saw heavier liquidation in 1997 due to drought, which forced some cow calf
operations to speed up herd liquidation.
Current economics have also served to extend this
cycle. Currently it is more
profitable to sell heifer for feeding than to retain them for breeding.
As such, cattle populations have been plummeting.
After all, Cow/Calf operations like any other business exist to turn a
profit, and they should continue to sell heifers as long as economics favor herd
liquidation over expansion.
 Cattle
cycles tend to peak when supply increases above the level of demand.
Since beef is a non-storable commodity
(limited storage life) the best judge of demand for beef is slaughter
rates. The cattle cycle tends to
peak when inventory tends to decline ahead of slaughter.
The 1980 to 1990 Cattle cycle saw inventory peak in 1982, while slaughter
rates did not peak until 1984/85. This
excess supply pressured prices down fin 1985 and 1986, until herd rebuilding
began in earnest. The price
depression caused by this excess demand is known as the Whiplash Effect.
The Whiplash Effect also occurs at the end of the
cattle cycle. When supply falls bellow demand – or slaughter on a relative
scale. At this point in the cycle, it becomes more profitable for
cow/calf operators to retain heifers for breeding than sell them, and inventory
levels begin to rise as demand is increasing.
Typically in this period, prices tend to be low and increase
precipitously as demand chases a limited supply of beef, which becomes even
smaller as ranchers retain heifers for herd rebuilding.
At the bottom of a cycle, slaughter tends to lag inventory, as seen in
1986 to 1990 and the last 4 years.
The Whiplash Effect is key to understanding the
Cattle Cycle and Cattle prices on a longer-term basis, as the Whiplash Effect
has traditionally seen prices reach extremes not justified by inventory levels
alone. By understanding the Cattle Cycle and where we are currently in it, the
astute Livestock Trader can plan market operations accordingly, as whiplash
periods tend to see extremely volatile pricing.
The current Cattle Cycle is long in the tooth, in
its 11th year, but no signs of changing slaughter rates indicate a
change currently. If slaughter
rates slow precipitously, prices could fall dramatically as too much supply
chases slowing demand.
|
www.CommoditySeasonals.com
