Is live cattle about to get slaughtered?
cattle prices have had a spirited rally in 2010 as the
supply contraction effects of the 2008/2009 financial
crisis began to dominate price discovery. Also, a temporary
rebound in U.S./global economic activity helped provide
a spike in demand. Both bullish factors are about to
come to an abrupt end.
temporary factor that also has propelled cattle prices
higher has been a huge spike in feed prices stimulated
by the historic Russian drought and apparent disappointing
U.S. corn yields. This bullish factor was way overplayed
in the cattle price discovery mechanism. This sets up
a classic contrarian bearish trade that should be very
profitable as each of these bullish forces evaporate.
The best way to play this bearish view from an overall
risk versus reward standpoint is to establish a December
2010: February 2011 bear futures spread.
bear spread, in this case, means you want to short the
December 2010 live cattle futures and go long the February
2011 live cattle futures. One profits on a bear spread
as the spread widens out or becomes more negative. Thus
a declining bear spread price graph (see "Where’s
the beef?" above) becomes increasingly more profitable.
The reasons why one should expect the December 2010
live cattle prices to fall in relation to the February
2011 live cattle prices are as follows:
slowing U.S./global economy: Everywhere one looks,
there are signs that the global economy is in a period
of slowing down. Short-term fiscal stimulus is running
out with no signs of a robust recovery. Beef is a
very expensive food item and is one of the first places
people cut back spending when an economic slowdown
demand falls off during the fourth quarter in the
United States. There tends to be a reliable downshifting
in demand for beef as more chicken, ham and turkey
are consumed during the holiday season.
Cattle farmers have been very profitable over the
last year, which has helped repair their fractured
balance sheets that emanated from the 2008/2009 financial
crisis. This newfound profitability will help promote
two bearish features to the cattle market price discovery
mechanism: increased weights per head as cattle farmers
look to cash in on higher prices and a stabilization
in cattle herd sizes from the sharp declines over
the last several years.
In the Sept. 1 U.S. Department of Agriculture (USDA)
report, cattle on feed grew at a larger than expected
2.8% from a year ago, August placements grew at 7%
while marketings grew at a 7% rate from a year ago.
This suggests that cattle farmers are feeding more
cattle and selling more cattle than a year ago, as
would be expected given the current levels of profitability.
major price correction in grain markets. There has been
much concern that escalating grain prices would increase
the costs for feeding cattle, thereby reducing cattle
farmer profitability and forcing a reversal of the trends
highlighted above. Such fears, although valid on a longer-term
basis should grain prices stay high, have very little
impact to cattle farmers' short-term decisions. If anything,
high grain prices stimulate greater cattle sales as
farmers look to cash in on what they have, instead of
feeding higher priced feed grain to their cattle herds.
The grain bull market move that has occurred over the
last few months has gone way too far. We have plenty
of wheat, soybeans and corn in the world to feed the
world over the next three months. As the harvest in
the U.S. progresses, feed prices should moderate and
take this bull element out of the equation.
Money flow characteristics of the commercial operators
tend to be short/hedged at major tops as they want to
lock in attractive prices. Currently, commercial operators
are short/hedged a record amount since the commitment-of-traders
data became available in 1986. The behavior of the commercials
operators suggests that they are very worried about
lower prices in the months to come and do not share
the current bullish enthusiasm of the market.
are numerous bearish fundamental factors unfolding over
the next three months in live cattle. A bearish technical
picture also is emerging. Instead of going short, the
superior way to play this bearish outlook from a risk/reward
standpoint would be to deploy the December 2010: February
2011 bear live cattle futures spread.
initial margin for a December/February live cattle bear
spread is $337.50 per spread. Traders should enter below
the major resistance level of -$1.50 with a -$3 target.
A stop at -75¢ would set up a 2:1 reward versus risk
because the live cattle market is about to get slaughtered
does not mean that your commodity portfolio has to as