It happened in April and May, and probably again since press time for this issue of BEEF — a market sitting pretty at a lofty level, before near limit-down moves in futures wiped the smile off a rancher’s face.
Five, six, seven bucks a hundred just vanish due to volatility, ruining a good price. In early spring, it was USDA’s stocks report on April 10 that boosted corn prices and buried cattle markets. Many stocker operators and cattle feeders were likely hedged against major losses via feeder- and live-cattle futures contracts. But what about cow-calf operators — a sector that lacks a true hedging mechanism?
Those with a calf crop ready for sale this fall only hope that prices return and resemble those projected early in the year by CattleFax. This spring, CattleFax forecast prices for 550-lb. calves to average about $172/cwt. this year, up 3% from a strong 2012. Of course, there’s no guarantee. Potential drought, which can impact cattle supplies and corn prices, is among the reasons CattleFax also stresses the need for price risk management.
Cross-hedging may be the answer. Matthew Diersen, a South Dakota State University Extension economist, says cross-hedging calves that will be sold as stockers this fall can be accomplished by using feeder cattle futures contracts. Options, forward contracts or Livestock Risk Protection (LRP) offered by the USDA Risk Management Agency (RMA) are also in his marketing tool chest.
A calf futures contract never caught on through the Chicago Mercantile Exchange, so feeder futures are the closest thing to it. But they’re contracts for 50,000 lbs. of 650-849-lb. steers, medium-large No. 1 and medium-large Nos. 1-2. That’s about 65 head on average. “But dividing the contract size by 550 lbs. implies that 90 head of stockers can be cross-hedged with each futures contract,” Diersen says.
In late spring or early summer, ranchers could cross-hedge their calf crops using October or November feeder cattle futures, contracts which have seen heavy volatility this spring. For example, in mid-April, October feeder futures were at $152 cwt., down about $4 in a few days, and $10 from where they traded in early March, $15 from February.
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If prices decline by October, lower returns on the cash side would be offset by gains on the futures side for cattle that were hedged. A wreck is covered. But basis isn’t.
“Cross-hedging does not fix the basis,” Diersen says. “Basis is usually not related to subsequent changes in futures price.”
Mike Murphy, CattleFax consultant, says ranchers should know their local basis trend at the time their calves are normally sold. “The basis is in a wider range relative to the calf market than the feeder market,” he says. “But it offers a range that would provide a margin.”
Basis can vary, depending on demand as well as cattle weight in relation to corn prices. “If the price of corn goes down, the basis will normally widen [between 500- and 700-lb. calves],” Diersen says.
“In South Dakota, for example, there would normally be at $10-$15/cwt. basis, or price spread, between five- and seven-weight cattle. But if corn goes up, as it did in the 2012 drought, the basis spread could go to nothing.”