Futures, Basis, And Summer Cattle Market
DR. ANDREW P. GRIFFITH
KNOXVILLE, TENNESSEE
At the time of this writing, summer and fall feeder cattle futures had declined $8 to $10 per hundredweight off their contract highs.
However, those same contracts were still trading $20 to $25 per hundredweight higher than the actual cash price. In general, this means there is an expectation of feeder cattle prices increasing $20 plus from spring through the summer months. However, this may be an uphill battle as feed prices continue to increase and fed cattle prices are practicing stalls as if they were getting their pilot’s license.
From the fundamental standpoint, strong beef demand and a reduced supply of feeder cattle should support cattle prices the next few years. However, higher feed prices and inflation are keeping the lid on prices strengthening in the current environment. Additionally, several regions of the country continue to experience drought, which also increases downward pressure on prices. Realizing and understanding the opposing forces brings to question what producers marketing cattle during the summer and fall months should do in the near term.
There are several options to consider when evaluating summer and fall cattle marketing. The first option and probably the alternative that many cattle producers will utilize is wait and see. This wait and see method could result in actual cash prices increasing $20 plus and the producer will actually realize the gain. This same method could also result in cattle prices increasing less than $20, staying the same, or even decreasing. The most likely scenario given the current market environment would be for cattle prices to marginally increase between now and the summer and fall marketing time period.
The second alternative is to employ some type of price risk management strategy including futures, options, LRP or a forward contract. These strategies would allow the producer to capture most of what the market is currently offering for the future dates in late summer and fall.
Thus, a producer with intentions of physically selling cattle in late summer or fall could lock in a price or set a floor on feeder cattle as long as basis converges.
Basis may be a new concept to some readers and old hat for others, but the simple definition is that basis is the difference between a local cash price and the futures price. In Tennessee and across the Southeast, basis tends to be negative to even during the summer and fall months depending on the exact weight class. For example, if the August futures are trading at $180 and a producer in Tennessee has a 50,000 pound load of 850 pound steers then that producer could expect a cash price near $177, because the historical basis in Tennessee is a negative $3 for August. However, in the past 12 months or so, the cash market and the futures market have been much slower to converge than in years past, and convergence should occur at the time of contract expiration. Thus, producers physically selling those steers in early August may have a much wider basis than those selling closer to the end of the month, because the market is slow to converge. This results in a lower price than expected.
This brings up a bigger issue for cattle being marketed in June and July, which do not have a feeder cattle futures contract associated with them, which lays the burden back on the August contract. The current market environment makes it extremely difficult to use the August feeder cattle contract to hedge cattle to be sold in June and July, because of the time between cattle marketing and contract expiration. These two months are looking to be better served by LRP insurance as the insurance product is indemnified based on the CME feeder cattle index (i.e. cash price), and there is less dependence on convergence to be successful.
Producers may need to consider some type of price risk management for summer and fall feeder cattle sales. With increasing input costs and the risk of feeder cattle prices declining, price risk management may help pay the bills this year. These suggestions are not meant to suggest doom and gloom on cattle market prices, but there are several factors that could pressure prices lower. ∆
DR. ANDREW P. GRIFFITH: Assistant Professor, Department of Agricultural and Resource Economics, University of Tennessee