Mitigating Risk With Discipline
A solid plan, grounded in an understanding of cost of production and market seasonality, can ensure success.
By Moe Agostino & Abhinesh Gopal
The National Pork Producers Council has identified over 100 risks that a hog producer can face in any given year.
Among the major issues are feed costs and futures (market) risk. Managing these two risks is easier said than done but, with
market know-how and a plan that is executed with precision and discipline, producers can be successful.
Since the start of the year, American hog price prospects have increased but so have feed cost expectations. For hog producers, the increase in soybean meal prices has had a bigger impact on feed costs than the rise in corn prices.
As of early March, May 2018 soybean meal futures had increased from their late June 2017 low of US$300/ton to almost US$400/ton. This jump is associated with a drought in Argentina, the worst the country has experienced in 70 years. As a result of these weather challenges, Argentina – which accounts for 40 percent of world’s exports of soybean meal – has reduced its 2017-18 soybean and corn production estimates.
A US$60/ton jump in meal prices increases the cost of production per live hog by US$1.85/hundredweight (cwt). As of
early March, 2018 corn futures had risen by about 32 cents per bushel (bu) since their low in mid-January, which raised hog producer costs by US$1.40/cwt. For every US$0.10 rise in corn prices, hog feed cost jumps by US$1.00/head.
Combining the estimated US$3.08/cwt cost increase from higher meal prices and the US$1.40/cwt increase for corn
results in a total jump in feed costs of about US$4.48/cwt.
Knowing seasonality trends can help producers plan to book feed costs in advance of weather problems significantly affecting crops in South or North America. Typically, the price of corn and soybeans tends to bottom in the fall (around Oct. 1) each year.
Seasonally, feed prices tend to bottom around Oct. 1 each year as supplies are generally at their highest during harvest.
Let’s look at an example of how this understanding of market trends can impact producers’ bottom lines.
In the fall of 2017, producers could have booked soybean meal and corn prices a year ahead at an average of US$320/ton or lower (+/- local basis) and corn at US$3.50/bu (+/- local basis) to protect themselves against higher feed costs. When compared to prices at the start of March, that would have yielded savings of US$70 to $75/ton on soybean meal feed and US$0.30 to $0.35/bu on corn feed.
Farmers could have “locked in” these prices in the physical market with local feed mills by pre-booking their feeds needs.
Alternatively, producers could have worked with commodities brokers to implement one of two strategies. First, they could have placed a cap with long (buying futures/going long caps a rising cost in the future) corn and/or meal futures. Buying (or going long on) a commodity futures contract helps to lock in the price of that commodity at the level on a specified day. Any rise in prices from then on would be offset with the long futures position.
Second, producers could have bought a call option with a July or September 2018 expiry. A commodity call option is a financial instrument “derived” from the commodity futures that gives the investor the right, but not the obligation, to buy (or go long on) the commodity futures contract at a specified price within a specific period.
In the first two months of the year, hog prices were higher than expected thanks to higher American pork processing capacity and stronger than expected demand. The prices rose despite expectations that 2018 pork supplies will be up as much as 4 to 5 percent over 2017 supplies.
Summer 2018 hog futures, as of early March, peaked near US$86/cwt and provided producers with an opportunity to lock in some early profits, equating to as much as US$10/head when combined with the lower feed costs outlined above.
Having a plan (which includes an understanding of your cost of production) and employing marketing strategies (such as hanging orders, sell futures orders and put options) is always prudent. Such strategies can help to trigger additional profits and add value to your marketing plan.
Being aware of seasonality (hog prices normally rise to their highest by mid-year and fall to their lowest in December or January), and knowing the highs and lows in cutout values can arm producers with an understanding of when and how much of their annual hog production to price each year.
As the old saying goes, “Bulls make money, bears make money and pigs get slaughtered.” Producers have no need to risk their entire hog operations on a gamble, waiting on higher pork prices. You never go broke taking a profit!
The marketing plan is never perfect. In some years, the prices are much higher than expected.
Seasonally, hog futures tend to bottom towards the end of November or early December as supplies are
at their highest. Futures can seasonally drop again by the end of March and carve out a bottom just before
the demand for the spring and summer grilling season.
For example, the industry faced significant challenges with Porcine Epidemic Diarrhea virus (PEDv) in 2013 and June hog futures traded above US $130/cwt. In 2012, a drought in the U.S. sent meal prices soaring to record highs of US $550/ ton and corn to US $8.00/bu.
In other years, in contrast, prices might be lower as the peak happens sooner than expected. Such a situation occurred in 2015, for example, when hog futures peaked in mid-May.
In either case, winning consistently for eight or nine times out of 10 means success. The plan is simple: buy low and sell high. It can also be repetitive, since we are doing the same thing every year: buying feed at a low and selling hogs at a high.
Executing the plan with discipline, meaning ignoring the “noise” around the markets, is the key to success!
Maurizio "Moe" Agostino is chief commodity strategist with Farms.com Risk Management. He has over 30 years of experience in commodity risk management.
Abhinesh Gopal is a commodity research analyst with Farms.com Risk Management. He is an agricultural commodities specialist with over 12 years of international agribusiness experience in banking, derivatives trading and consulting.
Farms.com Risk Management Inc. is an agricultural commodity marketing and price risk management provider for North American farmers, producers and agribusiness. The goal for the Farms.com Risk Management team is to maximize producer profitability while reducing risk. Farms.com Risk Management Inc. works with producers as advisors in the marketing of crops and/or livestock, such as market hogs, as well as during the purchase of feed inputs for livestock. Visit RiskManagement.Farms.com for more information.