Long-term fundamentals support cattle market

Long-term fundamentals support cattle market

by Chad Spearman, Analyst – CattleFax

 

Highlights

Fed cattle prices increased sharply this spring, reaching a high of more than $100 per hundredweight (cwt) in recent months.

Live cattle open interest is trending higher in recent months, increasing to a high of more than 450,000 contracts in mid-April.

Under current market conditions, the potential for increasing prices is appealing to beef producers and investors alike, so open interest levels in the cattle market could remain above historical levels for the foreseeable future.

Introduction

Fed cattle prices have rallied sharply higher this spring, supported by strong fundamentals that were magnified by tough winter cattle feeding conditions and increased money flow into the live cattle and futures market.

Discussion

Fed cattle prices recently rallied to the $100 per cwt mark basis according to the CattleFax weekly U.S. average. Prices were range bound from $79 to $88 per cwt throughout all of 2009, but prices broke out above the $88-level in mid-February this year. Since then, the trend has turned higher and gains accelerated into mid-to-late April as prices breeched the $100 mark for the first time since July 2008. In fact, prices have surged more than 26 percent from the fourth-quarter low in 2009 to the recent spring highs, marking the largest rally in more than 30 years. At the same time, total live cattle open interest has been on the rise and recently reached new record highs.

Live cattle open interest is the total of all futures and/or option contracts entered into and not yet offset by a transaction, delivery or exercise. The aggregate of all long open interest is equal to the aggregate of all short open interest. In other words, one open interest is equal to one long position plus one short position. Total open interest increased to record large levels in July 2008 amid the "commodity bull" run before breaking sharply lower into the summer of 2009 as the domestic and global economy deteriorated. In the second half of 2009 open interest began to trend higher and the trend accelerated early this year. During the first week of January, total open interest was near 320,000 contracts and by mid-April it had increased 30 percent to a high of more than 450,000 contracts.

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In order for open interest to increase there must be buyers willing to purchase a futures contract and sellers willing to offset that position by selling the market. The largest participants in commodity markets are referred to as non-commercial traders and commercial traders. The non-commercial category includes positions of managed funds, pension funds and other investors seeking exposure to an index of commodity prices. The commercial category represents hedging transactions, which in the live cattle market would be cattle feeders short hedging (selling) fed cattle futures to manage their risk or beef processing companies using long hedges (buying) to lock in purchase prices of live cattle. The bulk of the index traders positions are long futures positions that are rolled forward from contract to contract.

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Conclusions

Open interest has increased sharply this year due to a combination of both willing sellers and willing buyers. The short-term market fundamentals have been supportive to the market and the longer-term fundamentals are also very supportive. With global beef production declining for the third year in a row, beef demand stabilizing, U.S. beef exports up nearly 25 percent year-todate and beef imports down 23 percent, the potential for rising prices is not only good for beef producers, but also very enticing to investors looking to maximize the returns on their investments. For these reasons, open interest levels in the cattle market will likely remain above historical levels for the foreseeable future.

Tags: Beef Issues Quarterly, Issues Updates, Spring 2010

June 30, 2010