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Cheap feed, pricey beef

Register • Jan 27, 2014 at 2:26 PM

The cattle market has reached new highs repeatedly this month. We’ve known for years the U.S. cattle herd has been steadily declining. It currently stands at about 89 million head, which is the lowest it’s been since 1952. This hasn’t mattered much, as the decades-long decline in U.S. beef consumption has wilted domestic demand.

Furthermore, the impact of modern animal husbandry techniques has significantly increased the final weight of the cattle that hit the slaughterhouses, thus supplying the market with more total beef on fewer total animals killed. All of this bearish information begs the question, “Why are cattle prices so high and where do we go from here?”

The answer for us here in the United States is both political as well as structural. Japan was the No. 1 export market for U.S. beef prior to the mad cow scare of 2003, when it halted U.S. imports. It eased its policy in 2006, limiting imports to cattle less than 20 months old.

The 20-month barrier was a big sticking point for U.S. producers, who won’t even consider anything less than 16 months as ready for the feedlot. The feedlots are where cattle go to get fattened up prior to processing and can almost double their weight in a few months. Japan eased its restrictions back to cattle younger than 30 months, and this has made all of the difference in the world to U.S. packers, who’ve seen Japan jump back to its pre-ban highs.

The story transcends the rising sun, as exports throughout Asia have boomed and China’s growing industrialized middle class are able to afford red meat. Simple survival priorities allow us to recognize the change in tastes as it shifts from eating what they could find as a rural population versus their newfound ability to eat a better diet higher in protein and fueled by choice rather than necessity.

The Chinese trend is not only expected to continue, it is expected to accelerate by 10 percent per year over each of the next five years. China’s purchase of Smithfield Foods in September for almost $5 billion is no joke. Chinese beef imports through this year are 600 percent higher than last year.

The primary reason for the surge in beef exports to China in 2013 compared to 2012 is based on the same weather issues we saw here two years ago. Cattle become increasingly more expensive to keep as feed prices climb.

Farmers are forced to make the decision of continuing to feed the herd or sell them to the packers. This is the odd contradiction of short-term cattle prices. Droughts force extra cattle onto the market when crop prices spike rather than seeing their ending price increase proportionately with climbing input costs. The packers are well aware of this and wait patiently for farmers to panic before the packers start to buy. This passes the excess supply off at a lower price to the processors and grocers, who now have more beef to move.

Now, it’s time to pay the piper. Feed costs are exceptionally low. Wheat traded up to almost $19 per bushel in 2008 and corn hit almost $8 per bushel. They are now trading at $5.75 and $4.25 respectively. These prices allow the farmers and the feeders to hold back cattle and regenerate the herd at input prices many thought they’d never see again.

The combination of low domestic feed costs and strong global demand is going to force the U.S. consumer to consider alternate affordable protein sources. This picture is really playing out in the specialty and premium cuts, which continue to be sent overseas and leaves the U.S. packers now paying up for the cattle fattening up on the farms.

The USDA issued its Cattle on Feed report Friday. This number will provide a good indication of where the market is likely headed. The current market structure shows this to be a rally led by speculative fund buying and commercial selling. These two trading groups began taking opposite views on the market back in April, and it appears the funds have been the clear winners. These two trading groups began seriously facing off against each other in September, and the spread between them is now the largest I’ve seen it. Seasonally, we’re nearing a major peak in the cattle market.

While we clearly expect the long term, structural rally to continue, we may have reached a near-term tipping point, where a negative USDA report could provoke some serious profit taking.

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