Feeder cattle prices rebounded earlier this year, thanks to one of the oldest theories of economics — supply vs. demand. Feeder supplies can't keep up with feedyard demand.
With high corn prices boosting cost of gain, heavier feeder cattle that require less time at the feedyard bunk are holding their own in the market. But whether the cattle are marketed at 650 or 850 lbs., price protection may be needed.
In late winter, feeder-cattle futures were in the $100+/cwt. range, even after December corn continued its jump to a freakish $4.25/bu. and above. New crop wheat went above $5/bu., meaning some growers were weighing grazing vs. grain.
“We have a clear situation where feedlots are looking for heavier, older cattle,” says John Anderson, Mississippi State University Extension livestock marketing specialist. “We should see a shift away from calf-feds to traditional feeder animals, and even heavier. It's a normal response to high corn prices — feedlots are trying to reduce the amount of corn they have to feed.”
Pat Smith, longtime stocker and cow-calf operator at Dawn, TX, says “dealing with a fluke” corn price makes marketing his cattle an even bigger chore. “We're stuck with the brunt of it,” Smith says, referring to the pressure on calf, feeder and fed-cattle prices.
He normally tries to market stockers at 650-750 lbs., depending on availability of wheat pasture and feeder prices. This year, he looks to push yearlings to 800-850 lbs.
“We have some excellent wheat pasture (both owned and leased for grazing), the best since 2003,” he says. “There are some good graze-out conditions.
“With the corn situation, the bigger you can make them outside (the feedyard) the better off you are. Hopefully we can at least break even.”
He admitted that's a poor marketing attitude to have leading into the spring and summer. But with a $98 breakeven on cattle bought in November, late-winter May feeder cattle futures were barely above that level, in the $100-102/cwt. range.
Smith uses price protection through either options or hedges. “With options, I try to purchase whatever I can get for $1/cwt.,” he says. “For yearlings to be marketed in May, I bought $94 puts (for a $1 premium) in December.”
Those were March puts he rolled into May in early February, when the feeder market started rebounding. He was considering a straight hedge as March approached. “The options will protect us against a wreck,” he says. “We just hope the cattle bring a lot more than that when we market them.”
Securing a floor
Options can certainly provide the price insurance stocker-operators need. However, they can be expensive, especially in times of slim profits. Mark Green, a commodity broker for Schwieterman, Inc., in Garden City, KS, says options can help secure a floor price while leaving the upside open in the event of a rally.
“But, with these price levels and volatility, nothing comes cheap,” he says. Green suggests considering a strategy using a put-options spread, “something close to the money and something about $10 out of the money.”
For example, for seven-weight stockers coming off wheat pasture this spring, an at-the-money May $102 (cwt.) feeder cattle put would have cost $3.25/cwt. by itself. But by selling a $92 May put for 85¢, the cost of the price protection was lowered to about $2.40.
“That would have left the upside open,” he says, “and if the time value happens to deteriorate, perhaps the $92 put could be bought back for 15-20¢, lowering the cost of protection by even more.
“If the value of the futures price goes below $102, those puts could be rolled down (and a profit taken to lower the cost of protection more). The $102 puts could be replaced with a lower floor, while the upside would still be open.”
Green says that, in some situations, a straight hedge might have worked just as well. “If you have a $50-100 profit in those calves, then a straight hedge could work,” he says. “Just be sure it's okay with your banker.”
Anderson says producers should start planning a pricing strategy when stockers are first turned out.
“We're still seeing volatile situations with corn that could become even more of a problem for cattle producers,” he says, pointing out how corn continuously made strong jumps in price in late winter.
“Last fall, when corn prices started going up, it took $150/head off a lot of cattle. If we were to have a drought in the Corn Belt this summer, corn prices could be worse. If that happens, calves bought by stocker-operators that looked cheap early on aren't going to be that cheap.”
Anderson suggests producers consider some sort of price protection. “If they're in a low cost of production forage system, they should be able to find a favorable buy and sell market,” he says. “Cash-based forward contracts are easier to carry off these days with all the video and Internet auctions, as well as local sales. Or an options or straight hedge strategy can help protect the cattle investment.
“Buying puts for protection against the threat from the volatile corn market isn't a bad idea. Of course, every operator has a different situation that can impact their level of risk taking with futures or options.”
More weight at the ranch
Derrell Peel, Oklahoma State University livestock marketing economist, says the need to add more weight at the ranch will slow the rate of cattle turnover in the country and speed up the feedlot turnover rate. Feedlot inventories likely will continue to shrink at least through the first half of the year.
“For the last 3-4 years, we've maintained feedlot inventories by feeding fewer cattle for more days, and now we need to feed the same small set of cattle for fewer days,” Peel says.
Smith says putting more weight on yearlings in a drought year would be a disaster because of the need for an additional grain-based ration. “Our wet fall and good snows over the winter have made for good grazing,” he says.
For some bigger animals, he's extending their time on the ranch with a silage ration from forage grown on his farm. He also receives feedstuffs from a local cotton gin, and looks forward to wet distiller's grain from two regional ethanol plants under construction.
“If we can put more pounds on them here, we should benefit when we sell them to go on feed,” Smith says, adding he did some cross-commodity options trading earlier this year.
“When we saw corn starting to go up again, we bought some corn call options,” he says. “We just got out of them too soon.
“Hopefully, we can withstand this fluke corn market,” he concludes. “But it might be a while before it gets back to normal, if it ever does.”
Larry Stalcup is a freelance writer based in Amarillo, TX.