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More Room for Recovery on Cattle Prices?

November 8, 2016

Some say this is the most volatile cattle market ever, according to Purdue University Extension economist Chris Hurt. An evaluation of that statement would take considerable number crunching, he says, but everyone can agree that very few people expected cattle prices to go above $170 per hundredweight in late 2014, and then to fall below $100 in mid-October 2016.

“If finished cattle prices dropped by nearly $75 in the two years after the 2014 high price, how much did they rise in the two years before the high? The lowest weekly price of finished steers in 2012 was $113. Prices rose by $59 before falling by $75,” Hurt says.

Supply and demand for beef are the primary drivers of finished cattle prices, Hurt adds. Small supplies of cattle in 2014 were the result of the devastating Southern Plains drought and high feed prices in the 2010 to 2014 time period. Small cattle supplies meant high finished cattle prices. In 2015 and 2016, lower feed prices and more cattle coming out of feedlots resulted in lower prices.

“However, another little-reported potential driver of this price volatility lies in the fact that adjustments at different levels in the beef chain occur at different rates,” Hurt says. “Stated most simply, cattle prices and wholesale beef prices tend to adjust quickly to changes in cattle supply while retail prices adjust more slowly. As cattle prices rise, retailers are slow to increase retail beef prices. This keeps the quantity of beef demanded strong. More of the retail price is bid back into the cattle price. This may ‘overstimulate’ cattle prices.

“We are now on the other side of that relationship as retail beef prices have been slower to come down, keeping retail beef prices higher and weakening the quantity of beef demanded and lowering the share returned to the cattle price,” Hurt continues. “This may cause cattle prices to drop more sharply and overshoot on the downside. This overshooting on the downside may have occurred most recently. Packer and retail margins were narrow in 2014 and the farmer’s share of the retail dollars spent on beef was 55 percent, the highest annual level since 1993. This year the opposite is true, with packer and retail margins at record highs resulting in the farmer’s share of only 45 percent.”

Into 2017, Hurt says retail beef prices will likely continue to decrease and marketing margins will decrease with a greater share of the retail beef dollar getting back to the cattle price. Although it is difficult to accurately predict how large this impact will be, it seems within reason to expect about an $8 to $12 improvement in finished cattle prices just based on narrowing marketing margins in 2017.

“Trade is going to help as well in 2017,” Hurt says. “As U.S. beef prices come down in 2017, there will be less beef imports and more beef exports. USDA’s current projections are for 11 percent less beef imports and a 6 percent rise in beef exports. Even though U.S. beef production could be up 3 to 4 percent in 2017, the positive impacts of trade mean that per capita beef supplies in the U.S. may only rise less than 1 percent. If demand stays similar, 2017 finished cattle prices would be expected to be modestly lower than this year’s $118 to $120.”

According to Hurt, there continues to be a wide variation of opinions about the cattle market in 2017. Cash cattle prices have recovered about $7 in the past three weeks. Futures prices also recovered. However, futures traders remain far more pessimistic than the current fundamentals seem to suggest. Using futures prices on Nov. 7 as a proxy for cash prices suggests 2017 finished cattle would average in the higher $90s. USDA analysts who use fundamental price models are forecasting the average finished cattle price to be $112 to $121. The mid-point of their forecast range is $116.50 per hundredweight, which is more consistent with current supply and demand expectations.

“Clearly, wide swings in the cattle market over the past four years has made it difficult to establish benchmarks of what a high price or a low price for cattle should be,” Hurt says. “Cattle prices have lost their price reference points. Nevertheless, it should be remembered that it is the role of markets to ‘discover’ the correct price over time.

“The cattle industry has been through numerous shocks, including high feed prices and drought, in recent years,” Hurt says. “In trying to discover the right price, markets often have to overshoot and then undershoot. Finding the right price is not easy, yet markets are generally considered the most efficient way to find that elusive level. At the same time, we need to remember that the volatility implied in finding that right price has major financial consequences on participants in the entire beef chain, from cow-calf operations, to feedlot owners, to packers, to retailers.”

Source: University of Illinois