Margins have been and will likely remain challenging in the food business.
From a market standpoint, summer has passed. The beef complex now finds itself looking to fall and beyond. The resulting outlook is dictated by a potent tug of war between the drivers dictating supply and those shaping demand. And the ensuing price expectations and hedging strategies will typically be biased depending upon your individual focus. Either way, there are some unique dynamics at play.
Let’s begin by highlighting aspects around supply. The futures market has seemingly priced in shrinking supply as we transition into next spring. The April 2013 contract has been consistently trading around the $135-$136 range, while this fall’s December contract has made a push back up against $129. The focus upon supply constraints has fueled the rally-of-late and further buoys hopes for solid markets in the coming months.
That general sentiment has taken cues from indicators like USDA's Cattle On Feed report. Figure 1 highlights the six-month placement trends since January 2006. Running totals typically peak in late fall/early winter as spring-born calves make their way to the feedyard along with yearlings coming off summer grass. Then, as seasonal cattle supply fades, placements decline into the summer months.
This year’s fall-to-summer decline was unusually large (2.81 million head). There’s a variety of explanations for that occurrence. Whatever the reason, however, it's the outcome that matters – the inventory of market-ready cattle will begin to decline as fall progresses.
It’s also important to note that feedyards have remained relatively current through the summer. The past 120 days have seen sufficient marketing activity to allow cattle feeders to regain some market leverage in recent weeks. Marketings have averaged about 455,000 head/week since April. That’s about equal to last year’s rate and nearly on pace with the 465,000 head needed to work through summer supply in a systematic manner.
That’s all price-supportive, but let’s remember this is a tug-of-war for direction. The market is also grappling with demand. Therein enter the difficult discussions. Some of the broader worries from a food system perspective were recently articulated by William Delaney, Sysco CEO, in the company’s Aug. 13 earnings call. Delaney was asked about food inflation, the general state of the economy and potential influence on the consumer; this is how he responded:
"Until this economy shows more consistent improvement, until our customers participate in that, there’s going to continue to be a lot of pricing pressure up there. So I’m not saying that we can’t improve our margins over time, I’m just saying we need to take it one step at a time and right now, our goals are – is to reverse the trends that we saw this past year."
In other words, raising prices in a tenuous economy can prove to be a shaky strategy. As such, margins have been and will likely remain challenging in the food business.
The challenge is further underscored by August’s Consumer Sentiment survey (Figure 2). Most notably, the report highlighted consumer pessimism about the future outlook. Richard Curtin, the survey’s chief economist noted, “This uncertainty will increasingly cause consumers to become more cautious spenders.” What that means for beef expenditures remains to be seen, but certainly the observation possesses some important implications.
Specifically, last month's discussion mentioned the issue of demand destruction and the potential for corporate strategies to begin repositioning product offerings because of higher prices within this environment. That’s beginning to play out in a more public manner. For example, Burger King has announced it will be featuring new chicken items beginning this fall. Most likely, if that promotion is successful, we’ll witness some continuation of that strategy. There’s some heavy lifting ahead, given ongoing concerns around consumers and the general state of the economy, to get the Choice cutout firmly past resistance at $200.
Lastly, with the fall run right around the corner, it’s important to shift gears back to the ranch level and include some discussion around the feeder market. Figure 3 highlights the drought’s direct impact on feeder cattle prices. That is, higher corn prices stripped away about $150/head of value in just six weeks.
Feeder cattle have seen some recovery and stability during the past several weeks. However, there’s a long way to go before the final count on corn production gets done. That leaves the market vulnerable to disappointing harvest reports.
Factor in potential economy woes for the fed market, and there will be some choppiness moving ahead with both buyers and sellers on edge. Buyers don’t want to be overly aggressive and assume excessive risk. Meanwhile, sellers are being squeezed from both sides with a market that’s far less friendly than forecasted earlier in the year, coupled with substantially higher feed costs.
As noted earlier, this year is unlike any other – a lot of factors are swirling around the business. Never mind the possibility of a new round of quantitative easing and its potential influence on commodity markets. Overall, the beef complex remains amazingly resilient but don’t be surprised by some tussles back and forth in the coming months. And as always, remain objective, stay informed!
Nevil Speer, Western Kentucky University (firstname.lastname@example.org)