Sort & Cull

If Charles Dickens had been born a commodity broker instead of a world-class novelist, he might have described the current structure of meat futures as "the best of discounts and the worst of discounts." Clients might be puzzled by the stylish market call, but then again they'd probably be used to his weird phraseology like "great expectations of bullishness," "the bleak house of being long and wrong," and "sending margins to the old curiosity bucket shop."

Let's all thank our lucky stars that Dickens never wavered from his true calling. Still, I'm somehow finding his iconic contrast between two cities in the late 18th century as helpful in appreciating the discounted futures of lean hogs on one hand and live cattle on the other. When you think about these price realities against the backdrop of historical market behavior, they're about as incongruous as peaceful London and revolutionary Paris.

While the discount of nearby lean hog futures to spot cash is clearly more pronounced than its counterpart in the cattle complex, it's far less disturbing. Indeed, anticipating lower hog prices through the last third of the year is pretty much par for the course. In many ways, such expected erosion is a simple function of biology (i.e., as the market swings from merchandising the year's smallest pig crop to its largest).

Since 1990, the price decline for Iowa barrow and gilts from August to October has averaged $6.34 (dressed basis). The 5- and 10-year averages have been somewhat larger (i.e., $7.79 and $8.33, respectively). Logically, the seasonal price breaks tend to be larger during times of herd expansion. For example, the Aug-Oct price slide in the 2006-2008 boom period averaged $13.82.

As we move into the long Labor Day period, spot October lean futures is trading roughly $6 under the cash index calculation of September 3. Although all discounts seems to offend human nature on some level, the late-year hog board really seems quite reasonable at this point.

But if the measured and predictable caution of deferred lean hog futures now seems as reasonable as the Magna Carta and the Halls of Parliament, the highly unusual discounts now plaguing live cattle contracts are about as reassuring as Marie Antoinette stretching her royal, cake-loving neck before the guillotine.

While hog producers have plenty of price history to help them weather a sagging market through the second half of the year, feedlot managers have been geared exactly in the opposite direction. "Premiums" not "discounts" is the name of the traditional late-year game, thank you very much.

Since 2001, the price increase for the 5-area live steer from August to October has averaged $3.55. The 5-year average rally calculates as high as $5.36. And because the fed cattle market tends to bottom in July not August, the average midsummer to October rally is often closer $7-$8.

Armed with nothing more than this historical model (a dangerous lack of precaution, to be sure), I would expect October live futures to be currently floating well above early September cash instead of sinking far below it. Given a July cash average $148.89, the October board "should" be anticipating a fall rally near $156-$157 (i.e., $12-$14 above this week's cash trade and $16 greater where the spot month settled today).

It's a tale of two discounts all right. The hackneyed plot of the hog script hardly requires the creativity of Dickens. On the other hand, the surprising horror story of the late-year cattle market may be altogether worthy of Stephen King.

For more from John see www.feelofthemarket.com

(AG)

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