Sort & Cull

A well-known lover of antiques, my wife is very creative when it comes to decorating our house with interesting instruments of old technology. For example, her collection of old hand-irons are scattered around the ranch, creatively recast as paperweights, bookends and doorstops. What Grandma once laboriously hefted around the steamy laundry now lightly functions as frivolous decor.

There's something sad about outmoded things, stuff that once did a great job serving a specific function but no more. With better stuff perpetually lining up just off center stage, today's cutting-edge gadget or procedure is just hours away from tomorrow's trip to the landfill or craft fair.

Whether they fully recognize it or not, risk managers of beef production have been watching live cattle futures become increasingly obsolete over the last several years. Stripped of a reasonable relationship with the feedlot cash market, the board is no more effective as a hedging tool than a buggy whip is in starting an electric car.

The February delivery period at hand is only the latest example of extreme price volatility, the unpredictability of basis, and the broken mechanism of convergence. Through the first three weeks of the month, the basis (i.e., spread between spot February and the 5-area steer) has averaged $2.80 over cash. During the same period, the 2016 basis averaged $0.80 under while the 2012-2016 average near par.

With the initial CME tendering decision always in the court of producers, it's not surprising that we've seen absolutely no delivery interest so far this month. To a short hedger, such a surprisingly strong basis is like manna from heaven (i.e., the equivalent of a bonus of $40 per head from your secret Santa). No complaints here.

On the other hand, the long hedger of live cattle (if you spot such a rare Dodo, better take his picture) can only view such a basis shocker as a cruel joke, significantly hiking his input costs and definitely not what he was banking on.

Here's the point: If the lack of cash/futures convergence happens to randomly work in one's favor at one point, it could just as easily work against you at the next. Basis was never completely free from risk, but it was always much, much more predictable than flat price.

That's exactly why risk managers have traditionally donned with the confidence the armor of hedging.

But until the CME can somehow revive the critical reality of convergence, risk managers will find live cattle futures to be no more useful than an ornamental doorstop, a dangerous shadow of its former usefulness.

John A. Harrington

(AG)

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