Harrington's Sort & Cull

The Blinding Truth About Cattle Futures

By John Harrington , DTN Livestock Analyst

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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CURTIS RUSSELL 2/10/2016 | 7:21 PM CST
The disconnect between cash and futures has been inevitable since the 1980's, when Paul Engler and Cactus Feeders decided to let his neighbors determine the price of his cattle. With the minimal cash trade in fed cattle today, with Texas the poster child for lack of price discovery, it is inevitable that the cattle futures became the playground of those with enough money to push the market where they want it to go.
If we really want to fix this market there are three things that need to happen ASAP.
1. Start negotiating prices for fed cattle. I don't care if it is for live cattle, dressed carcasses or Choice YG2's with premiums and discounts for off spec, we cannot have a viable market and true price discovery if pricing 100% of the cattle is left up to 20% of the total volume of cattle available.
2. Make it painful for noncommercial longs to take delivery, or noncommercial shorts to make delivery, of both fed and feeder cattle. The cash settlement of the feeder cattle futures certainly accelerated the demise of the viability of futures as a method of laying off risk for cattle producers. Making it easier for commercials to make or take delivery would go a long way to bring convergence during delivery months.
3. Stop blaming the specs, they are simply taking advantage of the situation that cattle producers brought on themselves. Commodity funds, hedge funds, daytraders etc. would not be able to cause the havoc we currently have in the cattle markets if cow-calf producers, backgrounders, stockers, feeders and packers had not turned price discovery over to a tiny handful of crotchety old-school feedlot managers and a bunch of cowboys that ride nothing more than a desk chair. Let's get back to old fashioned price discovery, where buyers and sellers agree on a price before product changes hands, at least until we can come up with a new way of ensuring adequate price discovery.
Bonnie Dukowitz 2/7/2016 | 8:17 AM CST
Gambling is correct. Buying and selling chips and paper, rather than grain and meat.
peter wright clark 2/5/2016 | 4:02 PM CST
Let's be honest about this. the idea of futures in the 60's was to even out the swings and promote discovery-- and for quite awhile it has worked, but no longer! Look at today on the DOW- down 200 plus and "the hottest game in town -- feeder cattle --get slammed! Why do all the traders want to be cowboys? all they are doing is screwing up our business to where price discovery no longer works. A true tale of the tail wagging the dog!! Yes, there is now so much dependency on futures that getting rid of them is a question I can't answer.. Hopefully, we can have an honest discussion about this mess1 Skip Wright- Clark
H. Clay Daulton 2/5/2016 | 8:21 AM CST
You're a little bit late to the party. I was California Cattlemen's Assn pres in 1983, when CCA officially took on futures for exactly the same reasons you state. I hate socialism, but Bernie's right in one issue: some entities are too big and monopsonistic, and thus need to be broken up. But your saying so would threaten the advertising base, and the same goes for most other advertiser supported publications; same, even, for a lot of cattle associations. So, been there, tried to do that; just live with it!
Dean Hunt 2/4/2016 | 7:41 PM CST
I couldn't agree more