What a Difference a Year Makes!

Have a plan to manage risk, because the markets are unpredictable.

By Moe Agostino

In 2009, the hog industry was shocked with the outbreak of H1N1 virus, also commonly known and misconceived as "Swine Flu." Historically, diseases of this sort that seem to be tied to a commodity linger for 3 to 4 months but usually pass with time. That is exactly what happened. Last year, by the time the end of August rolled around, someone rang the bell at the bottom and the CME Lean hog futures never looked back.

It almost looked like a repeat of 1998 in terms of how low prices would go, but the December 2009 futures contract hit a low of US $43/cwt only to rebound from these depressed levels and closed out at US $64.57/cwt.

No one expected demand to be as good as it was, particularly after experiencing one of the worst recessions since the depression of the 1930's. With more time came higher prices and as we entered 2010, U.S. supply was tracking 5.0% lower than the December Quarterly Hogs and Pigs Report was suggesting (a drop of 2.5-3.0%).

A lack of good quality corn caused hogs to go to market lighter, thus providing for lower supplies. In addition, a few winter storms caused transportation issues, artificially causing the U.S. pork carcass cutout to achieve it's highest-ever January level at US $79/cwt. (See Pork Carcass Cutout Chart)

No wonder pork belly and hog futures are considered some of the most volatile commodities in the world.

Pork Carcass Cutout

So now what?

Many economists remain bearish, as supply has not liquidated enough to create long-term profitability and sustainability in the pork industry. Enter demand once again in late 2009/2010. Even with a global recession and China out of the market, export demand continued to improve as 2009 wore on.

With the worst behind us, a combination of lower supplies and higher demand is causing historically high CME lean hog futures. For example June hog futures have achieved a high of US $85.60/cwt so far in 2010. June is now trading at the 97.18% of its historical range. This simply means there is a 2.82% probability that prices may go higher but a 97.18% chance that prices may move lower. At these lofty levels the risk is high if a producer decides to do nothing and sell into the cash market. (See Monthly Nearby Lean Hogs Chart)

Monthly Nearby Lean Hogs (CME)

Historically, hog futures have rarely seen prices much higher than US $90/cwt, except for the June 2009 futures contract when on July 3, 2008 it rallied to a record high of US $100.25/cwt. Seasonally we usually enter highs in late May and early June every year, but there is always an exception to the rule, like 2009.

Looking Forward

Is 2010 going to be placed into the record books? With time on our side we may just do it, but the global economy needs to continue to recover. With a 4.5% GDP global growth and improving consumer confidence, this could create enough demand to achieve higher prices. This is welcome news after what many producers experienced last year. Many want to forget 2009 but expansions plans are now being rumored once again. This will be premature as many banks are not really in the mood to lend money - which is good news for the industry right now.

Feed prices have remained in check and overall cost of production is lower, allowing pork producers to finally lock in profits for the spring, summer and fall/winter months of 2010. Fear was rampant in 2009 but greed seems to be the name of the game in 2010.

Remember, the futures market is about expectations at some point in the future and current summer 2010 hog futures have already factored in better export demand and lower supplies due to seasonality. The risk moving forward is not that a producer will leave US $5-10/cwt on the table by booking hogs at current prices. Rather, it is consideration of the downside risk. What if prices fall US $10-20/cwt? In 2005, June hog futures rallied to US $82/cwt by the end of February and by the time the contract expired it closed out at US $68/cwt, a US $14/cwt drop or US $28/head fall.

Final Thoughts

There is more downside risk from current levels but no one ever gets hurt taking a profit. As the old saying goes, "Bulls make money, bears make money, and pigs get slaughtered." Many people were surprised with the v-shape recovery in the economy last year and we may be just as surprised with the strength in the hog market in 2010.

Finally, some last words of wisdom: Sell on strength - markets can be irrational a lot longer than you or I can stay solvent and "a fool with a plan will always beat a genius with no plan."

Editor’s Note:Moe Agostino is Managing Commodity Strategist for Farms.com Risk Management. For more information on managing risk in your crop and/or livestock operation, contact Moe at: moe.agostino@farms.com. To learn more about the markets, go to: www.riskmanagement.farms.com