Weekly Roberts Market Report

US - The grain industry wants futures to have a one-hour futures trading pause after the release of the WASDE report, writes Michael Roberts.
calendar icon 13 July 2012
clock icon 9 minute read

Michael T. Roberts
Extension Agriculture Economist,
Dairy and Commodity Marketing,
NC State University

DAIRY CLASS III futures on the Chicago Mercantile Exchange (CME) closed up on Monday with the exception of the nearby spot month. JULY’12DA futures closed at $16.60/cwt; down $0.11/cwt but $0.04/cwt higher than last Monday’s close. The SEPT’12DA contract closed up $0.03/cwt at $17.90/cwt and $0.35/cwt higher than last report. With cooler weather in store for a while, milk production is rebounding a bit increasing milk receipts. However, hot weather is still in store, but cooler nights are key. The main concern for milk production now is feed costs. Some dairy producers are looking at taking drastic measures to reduce their herds. Please see chart:

Commercial disappearance of cheese was up 1.2 per cent for the first four months of 2012. Demand for butter is seen as good-to-very-good. Class III futures were: 3 months out = $17.34/cwt ($0.63/cwt over last Monday); 6 months out = $17. 54/cwt ($0.40/cwt over last report); 9 months out = $17.44/cwt ($0.35/cwt over last Monday’s close); and 12 months out = $17.35/cwt ($0.39/cwt higher than last report).

LIVE CATTLE futures on the Chicago Mercantile Exchange (CME) were mixed on Monday with nearbys down and deferreds up. The AUG’12LC contract closed at $119.050/cwt; down $0.150/cwt and $0.225/cwt lower than last report. DEC’12LC futures closed at $127.500/cwt; down $0.35/cwt but $0.65/cwt higher than last report. Live cattle prices reflect concerns among traders that the long summer heat wave will depress demand while raising supply. Wholesale beef prices were mixed on Monday. Late Monday USDA put boxed beef at $190.51/lb; down $2.14/cwt and $4.78/lb lower than a week ago. According to HedgersEdge.com, the average packer margin was lowered $24.40/head from last week to a positive $46.55/head based on the average buy of $116.68/cwt vs. the breakeven of $119.83/cwt. USDA put the 5-area average price at $117.04/cwt; $0.53/cwt higher than last report. See chart:

Stable export traffic amid weakening demand is underpinning domestic prices.

FEEDER CATTLE at the CME closed lower on Monday. It seems no one really wants to feed stockers or feeders right now. The reason … high feed costs and burned up pastures. The AUG’12FC contract closed $2.250/cwt lower at $144.275/cwt and $5.375/cwt lower than last report. NOV’12FC futures closed at $151.350/cwt; down $2.775/cwt and $4.20/cwt lower than a week ago. The heat wave across much of the US continues to upset feeder-cattle futures. Developing drought conditions are damaging the coming crop and sending feed prices rocketing.

Feeder futures have fallen almost 11 per cent since mid-June, when the rally in corn took off. Further declines in pasture conditions and tightening hay supplies are leading to more and earlier selling of young cattle that would eventually make their way to the feed yards. For Monday 7.9.12; estimated receipts at the closely watched Oklahoma City market were put at 7,000 head vs. last week’s 1,687 head and 5,916 head this time last year. Feeder steers and heifers were $2-$6/cwt lower with the least decline in prices seen for heavier steers that won’t require as much feed. Steer and heifer calves were steady to $10-20/cwt lower. Demand was considered moderate especially for new crop calves. Quality was plain-to-average.
Feeders were slightly thin to moderate flesh condition coming through this heat. The weaker nearby basis vs. the strong October premium is supportive to cash speculators. Record heavy carcass weights are still a concern and risk of slowing summer beef movement remains a caution. A slower sales pace might be a good consideration based on the market price structure. However, near-term gains may be limited by the approaching index roll. Following is a review in basic price risk management. The act of selling futures (going short) allows cattle owners to establish an approximate sales price before delivery.

If prices fall, the lower revenue in the cash market is offset by a financial gain in the futures market. If prices rise, the financial loss in the futures market is offset by greater revenue in the cash market. For example, a feedlot expects to market cash cattle during February and knows that on average basis levels during February (basis = the difference between the local cash price and the futures month in which the cattle will be sold) are about $1 under the February futures price. The feedlot executes the short hedge by selling February futures contracts for $87. This establishes an expected sales price of $86 (the futures price adjusted by the basis expectations).

When the cattle are ready for market, the futures contracts are bought back and the cattle are sold in the cash market. If basis levels at the time of the cash sale are near expectations (cash prices $1 under the futures), producers will net the hedged sale price of $86 (less transaction costs). If basis levels are stronger than anticipated (greater than $1 under), the short hedger will receive a higher-than-expected net price. If basis levels are weaker than anticipated (less than $1 under), the short hedger will receive a lower-than-expected net price. Another alternative is to use options on futures contracts to manage price risk.

This is a much more flexible pricing tool, but the flexibility can come at a high cost. At this time of year when changes in weather conditions can greatly alter cattle performance, feeding costs, and market sentiment, the use and costs of futures options can become more palatable. The basic tools of the option market are put and call options. For buyers the put option grants the right but not the obligation to be short the underlying futures market, while the call grants the right but not the obligation to be long the underlying futures market.

In the simplest of terms, cattle owners might think of the purchase of a put option much like the purchase of an insurance policy. For example, a cattle owner expecting to market cattle in February might purchase a put option on February futures at a strike price of $86. Let's say the cost of the right but not the obligation to be short February futures at $86 is $2. The purchase of this option locks in a price floor on February cash marketings near $83—the $86 strike price minus the $2 cost of the option minus the $1 expected basis level. This strategy eliminates the downside risk below the strike price (minus of course the premium and basis fluctuations—Owners would sell their cattle in the lower market with appreciation in their futures options position offsetting the cash declines.

However, in the event that futures prices continue rally above the strike price the producer is not obligated to execute the option and can participate in the price advance. In this example we might assume that February futures continue to press upwards towards $95—cattle owners could then sell their cattle in the cash market and let their options expire worthless, netting $92 (the futures price minus the $2 in option premium and $1 basis).

This table shows the maximum price a producer could pay for feeder cattle and still break even, assuming the costs and conversion/performance factors listed above. Producers should remain aware that calculations are based on averages. Courtesy DTN.

The CME feeder cattle livestock index was placed at 146.61; even with Friday’s close but 1.05 lower than last report. See chart:

CORN futures on the Chicago Board of Trade (CBOT) closed up again on Monday. The JULY’12 contract closed at $7.750/bu; up 32.0¢/bu and 821.75¢/bu over last report. The DEC’12 contract closed at $7.300/bu; up 36.75¢/bu and 74.5¢/bu over last Monday’s close. Weakness in outside markets limited gains. USDA will issue it World Agriculture Supply Demand Estimates Wednesday, July 11. USDA is expected to drop its yield production forecast by 7.2 per cent. Hot weather seen as limiting supply is greatly affecting prices. USDA reports corn in 18 states are hurt by the drought reporting that 30 per cent of the US corn crop in poor-to-very-poor condition. The same rating was 22 per cent this time last week. The amount of US corn rated in good-to-excellent condition was put at 40 per cent vs. 48 per cent a week ago. The grain industry wants futures to have a one-hour futures trading pause after the release of the report. Most pit sources say they and the large funds expect USDA to cut production forecasts by as much as 7.5 per cent for US corn. Commercial traders are pushing the markets higher while non-commercials are buying enough to keep pace. The national average basis for corn fell 5.0¢/bu to 10.0¢/bu over September futures. Exports were neutral with USDA putting corn-inspected-for-export at 22.845 mb vs. estimates for 20-25 mb compared to the 36.6 mb needed to keep past with USDA’s demand projection of 1.65 bb for the 2011-2012 marketing year. Please see chart:

It would be a good time to consider pricing more of the 2012 crop.

SOYBEAN futures on the Chicago Board of Trade (CBOT) closed up on Monday. The JULY’12 contract closed at $16.550/bu; up 45.25¢/bu and $1.228/bu over last Monday. NOV’12 futures closed at $15.476/bu; up 42.0¢/bu and $1.096/bu over last report. The soybean crop is stressed as well. And, like corn, trader worries drove prices to a new record on Monday. USDA reported that 27 per cent of the US soybean crop was in poor-to-very-poor condition vs. 22 per cent this time last week. Only 40 per cent of the crop was in good-to-excellent condition. Soybeans are flowering and this is a very critical time for yield potential and development. USDA is expected to cut yield forecasts for the US soybean crop by 3.6 per cent due to the drought. While corn dominated the news soybeans remained bullish and the one most pit sources tell me they are concerned about. The inverse in the new-crop forward curve strengthened, with the November extending its premium over the July 2013 contract by almost $1.50/bu. Strong buying was seen in the soybean meal market as well. Exports were viewed as bullish. USDA put soybeans-inspected-for-export at 18.9 mb vs. estimates for 10-15 mb. This well above the 13.3 mb needed to stay on pace with USDA’s demand projection of 1.335 bb for the 2011-12 marketing years. Please see chart:

Cash prices are rallying on a weak dollar and dry weather in South America that is expected to reduce South American crop production. It might be a good idea to sell the rally.

WHEAT futures in Chicago (CBOT) closed up on Monday. JULY’12 wheat futures finished at $8.106/bu; up 19.5¢/bu and 56.25¢/bu over last report. The JULY’13 contract closed at $8.310/bu; up 13.25¢/bu and 30.5¢/bu over this time last week. Farmers have harvested 75 per cent of the US winter wheat crop as of Sunday vs. 56 per cent harvested this time last year. This is up from 69 per cent a week ago. Kansas says its winter wheat harvest is complete. USDA put the US wheat crop in good-to-excellent condition at 66 per cent vs. 71 per cent this time last week. Hot weather in the US and severe floods in Russia’s wheat basket region in Krasnodar are pushing world wheat prices higher. The September CBOT contract gained again on the December 2012 contract, showing solid demand both domestically and overseas. Higher corn and feed prices are also driving wheat prices as if corn gets much more expensive producers will feed more feed-grain wheat. This greater demand vs. lower production is expected to weaken global wheat stocks and support higher prices. USDA put wheat-inspected-for-export at 14.898 mb vs. estimates for 18-24 mb. Weekly exports needed to stay on pace with USDA’s demand projections of 1.15 bb are 22.2 mb. This is 7.3 mb more than was exported this week. It would be a very good time to price some of the 2012 wheat crop.

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