Sort & Cull

Sometimes there's nothing like a blinding blizzard to help you see clearly. Though I'm trapped in a major snowstorm Tuesday afternoon with gale-force winds and half-block visibility, a painful market truth is beaming like the summer sun at high noon.

Cattle futures are seriously broken, at least as a meaningful risk-management tool for cow-calf producers, feedlot managers and beef processors.

I'm not entirely sure why, but the board's behavior has become largely divorced from day-to-day fundamentals of supply and demand. Technically speaking, contract specs have not changed. Now and then, price direction of futures will even momentarily cohere with actual cash and produce developments.

But anyone who has closely monitored the situation over the last several years can hardly deny the devolution of a serious disconnect between the realities of futures and cash, two markets that must work in some sort of consistent tandem if the theory of hedging is to own critical integrity.

The extreme winter weather of early February is causing me to voice misgivings long festering in the wings. For months and months, risk managers have been struggling to harness the board's chaotic power, agonizing over wild price swings and completely unpredictable basis levels. Such pretending that hedging and marketing prudence go hand in hand has proven to be extremely expensive. Indeed, commercials "playing it safe" on this strange game board may be simply taking a longer road to financial ruin.

Adverse production weather, whether in the form of drought, flooding or blizzard, should be typically viewed as bullish in terms of ag commodity prices. Of course, no market is simple enough to always react to single factors in a uniform fashion. No reasonable farmer or rancher expects a market attempting to mirror the uncertain world of price to be completely logical on a day-to-day basis. Yet they necessarily expect a predictive market to at least weigh speculation in a consistent way, sharing with them some general assumptions about the inherent nature of specific commodities and their value.

So when live and feeder futures opened no livelier than mixed Tuesday morning with livestock health and safety seriously threatened by Mother Nature across a wide stretch of beef production territory, I saw it as the latest sad example of how a once-vital form of risk management has become hopeless corrupt and useless. Yes, I'm aware that sinking oil prices caused outside markets to once again haunt the CME. But I'm also aware that spot Feb live remains nearly $3 below recent feedlot. I'm also aware that nearby live contracts have long ignored the need for weather premiums, regardless of such a structure's common sense in the face of how a savage winter can shred first-quarter meat production.

Perhaps there are wild and wooly speculators out there, born and bred riverboat gamblers who are absolutely addicted to the unknown, that don't think cattle futures are broken in the least. But if commercials need speculators for purposes of liquidity and price discovery, I think it's also true that speculators need commercials for many of the same reasons. Somehow, this delicate balance has gone completely out of whack and CME officials need to find a way to fix it.

That might require a major redefinition of contract specs or a reintroduction of delivery requirements or greater restriction on position limits. Frankly, I'm not smart enough to suggest a sure cure. But I think I'm at least savvy enough to know when a serious plague is spreading. They say the first step toward real health is admitting that you're sick. Until cattle futures find effective medicine, risk managers will be engaging in just another luck-based form of gambling.

For more of John's commentary, visit http://feelofthemarket.com/…

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