Sort & Cull

The story of basis is always rich with details about assumed supply and demand. You can always get a great reading of trading expectations by clocking the difference between the reality of spot cash and the premium or discount of deferred futures.

Of course, that doesn't mean that said expectations are right or unchangeable. Just consider the recent rags-to-riches performance of October lean futures and the surging early fall basis.

On June 20, the October board trailed the cash lean index by no less than $18.78. While sinking anticipation from summer high to fall low is par for the market course, such an enormous, record-setting discount struck me as state-of-the-art pessimism.

This extremely dour outlook by summer bears was essentially based on three considerations: 1) the record-large spring pig crop (i.e., 30.11 million head) would logically result in record-large fourth quarter pork production; 2) red-hot pork demand enjoyed through the second quarter (e.g., carcass value averaged $92.44, 11% higher than April-June 2012 despite the fact that commercial tonnage was virtually unchanged) was not likely to be sustained through the end of the year; 3) late-year carcass weights were likely to be heavier than 2012 thanks to prospects for cheaper feed.

Such doom-and-gloom arguments must have really resonated with both commercials and specs given the discount's stubborn legs. By the end of July, the October discount still measured $17.66. As late as Aug. 23, the fall board ran $11.88 behind the cash index.

But suddenly the world changed. In less than two weeks, the basis has exploded like a weightlifter on steroids.

Remembering that the calculation of the cash index has a one-day lag, it looks like the early September basis will close the week a mere 0.70 under (i.e., 91.60 cash index versus 90.90 October lean futures).

In explaining this dramatic basis shift, I thinking it's telling that October futures did the lion's share of the heavy lifting. From Aug. 22 to Sept. 6, the spot contract soared from 84.40 to 90.90. Indeed, the bullish lean hog pit closed the week with October through April setting new contract highs.

All three of the bearish bets discussed earlier have been turned upside down. Growing nervousness about the real impact of porcine epidemic diarrhea virus is causing analysis to reduce projections of fourth quarter tonnage by as much as 3%-5%. Furthermore, pork demand confidence is not fading as we march deeper and deeper into the second half of 2013. Finally, the late-season recovery in corn and bean prices has cast doubt on theories of heavy carcasses.

None of this means that late-summer perceptions are necessarily more valid that early summer perceptions. Still, such a dramatic shift in basis at least suggests that surprising changes in fundamentals are in the wind.

The Sept. 1 Hogs & Pigs Report will be released in three weeks (i.e., Sept. 27). While quarterly snout-counts have turned into yawn-fests in recent years, I have a feeling that this one will have traders and producers perched on the edge of their seats.

(AG)

© Copyright 2013 DTN/The Progressive Farmer. All rights reserved.