Margin Watch Notes: October

November 2, 2009 by Chip Whalen

Hog Margin Watch

Hog margins improved during the last half of October as the rally in hog futures continued while feed prices began to soften. Most of the hog market strength has been focused on nearby contracts where margins are still negative; however, optimism appears to be improving with China lifting their U.S. pork import restrictions. Meanwhile, although the corn & soybean harvests remain delayed and quality issues have arisen with the extremely wet autumn, there isn’t much historical evidence to suggest that yields will be sharply reduced from current forecasts. For most operations, it is still possible to protect a breakeven margin from Q2 2010 through the end of next year with flexible price strategies that will allow for an improvement in that margin should hog prices continue to recover and feed costs decline. These strategies generally feature protecting a range of higher feed prices and lower hog values. Also, on a case by case basis, taking on the obligation to sell hogs at higher levels that would represent a historically strong profit margin.

Dairy Margin Watch

Milk production margins improved since the middle of October, and now are above breakeven in Q4. Margins are similarly positive through all of 2010 which is allowing producers the opportunity to protect a breakeven level on their dairy operations while allowing for improvement in that margin over time. Milk prices have been firm in nearby months and are now trading at their highest levels since June on optimism surrounding the latest CWT herd retirement program. Recent strength in cheese, NDM and butter prices have all helped support ideas that demand is improving as well which has allowed futures prices to maintain their strength over the past two months. Meanwhile, a clearer weather forecast to harvest corn and soybean crops during the first week of November and sentiments that the market has become overbought is putting pressure on feed values which is also welcome relief to dairy producers. Protecting a range of higher prices on corn and soybean meal futures while using minimum/maximum price strategies on milk futures look attractive given current forward dairy margins.

Beef Margin Watch

Beef production margins were generally flat to slightly weaker through the end of October as lower prices in both feeder and fat cattle were largely offsetting. Negative beef packer margins and slumping boxed beef demand have put pressure on cattle prices, although a generally tight supply of on-feed inventory continues to support optimism of higher prices next year. In the meantime however, there is ample availability of cheaper protein alternatives in the domestic market, and consumers continue to be frugal at the meat counter with unemployment hovering around 10%. On a positive note, it does finally appear that corn producers will have a window of opportunity to harvest their crops in early November as conditions dry from what has been an extremely wet autumn thus far in the Corn Belt. Ideas that the market has become overbought and compromised export demand have pressured prices since the middle of the month. Strategies to protect a range of higher prices currently look attractive for both corn and feeder cattle, while minimum/maximum price combinations are attractive for live cattle.

Crop Margin Watch

Corn crop margins deteriorated slightly through the end of October as futures began to weaken with ideas that the market has become overbought. Basis was largely flat, although the forecast appears favorable for the first week of November which should allow more supply availability to hit the cash market near-term. While the extremely slow pace of harvest has raised fears of crop losses and compromised quality, there is no historical evidence suggesting that final yield will be significantly below current assumptions. Meanwhile, the sharp rally since the beginning of October appears to have compromised export demand which is also a concern given the large supply. Unlike the middle of October, the market now appears to be encouraging storage given current futures spreads, and weak basis quotes in the cash market may likewise discourage a spot sale. Strategies to protect a range of lower prices would look attractive for the 2009 crop, while the stronger profit margin indicative in the 2010 crop is likewise presenting a good opportunity to secure protection there with a similar strategy.

Soybeans Margin Watch

Soybean crop margins were flat to slightly weaker through the end of October as both futures prices and basis began to deteriorate. While the futures market rallied sharply in the first half of the month, there is concern that prices have become overbought with the possibility that demand from China may be slowing down. Although the harvest remains severely delayed across the Midwest, most of the attention has been focused on collecting soybeans as the crop would be more vulnerable to damage if left in the field while nearby premiums have remained very firm due to the weather issues in the Delta. The relatively strong profit margins available for the 2010 crop should not be overlooked given the fast start to planting that both Brazil and Argentina are off to with expectations of record crops in South America this growing season. It would still appear that selling this year’s crop at harvest and re-owning a range of higher prices on paper would be the preferred strategy while there are many flexible price strategy combinations to consider on the 2010 crop to protect next year’s profit margin.

Wheat Margin Watch

Wheat crop margins were essentially flat through the end of October as a sharp rally since the middle of the month corrected in the past week. Basis values have been largely flat as well, although are beginning to show slight improvement. Most of the strength in futures prices has been tied to short covering, although it is interesting to note that open interest has been very steady through this rally. It appears that a transfer of ownership has taken place which has allowed open interest to remain steady. Last week’s selloff was tied to concerns that U.S. wheat is becoming uncompetitive in the world marketplace, which will limit profit margin opportunities on the 2009 crop. On a positive note, new-crop margins continue to look very attractive for producers who have been able to plant this fall, and flexible price strategies that protect a range of lower prices and obligate a sale at higher levels look particularly attractive for 2010 wheat. A similar strategy could be used on old-crop wheat using a deferred contract, with futures spreads suggesting the crop should be stored through the winter.

About the Author

There is a risk of loss in futures and options trading. Past performance is not indicative of future results. The information contained in this publication is taken from sources believed to be reliable, but is not guaranteed by Commodity & Ingredient Hedging, LLC, nor any affiliates, as to accuracy or completeness, and is intended for purposes of information and education only. Nothing therein should be considered as a trading recommendation by Commodity & Ingredient Hedging, LLC. The rules and regulations of the individual exchanges should be consulted as the authoritative source on all contract specifications and regulations.