Where's the Hole in Hog Marketing?
With PED a major event affecting the hog market this year and, more importantly, a major influence on individual producers' decisions to expand or contract the herd, the outlook for hog futures has been very mixed. PED (porcine epidemic diarrhea) is a virus that has affected a percentage of the hog herd for 2014. It looks like the bulk of this disease has affected the herd in the January and February window. Theoretically, this would suggest supplies will be tightest in mid- to late summer.
The futures market has certainly reflected this concern with prices rallying from just over $100.00 to over $130.00 per hundredweight on the June and July contracts. June peaked in early March at $133.42, and July peaked on March 28 at $128.95. Since then, however, there's been a refocus on when the tight inventory may show, and June is now trading at $121.80. July, on the other hand, was at one point trading a $5.00 discount to June and is now trading well over a $6.00 premium, near $128.00. It looks likely that the tighter inventory will be in the July, August, and possibly October window. August is now trading near $127.00, and October is above $106.00. In March, October was trading at $84.
Since PED broke, there have been a number of discussions on how to handle this. Farmers have certainly been more perceptive in their handling of hogs, and movement of supply is critically watched and monitored. They've done an excellent job of trying to contain this disease. There is no cure yet. In addition, from a marketing perspective, the December deferred futures contract is trading near $95.00. We feel this is undervalued. PED could resurface sometime later in the year, especially if immunity wears off.
We are not sure producers are confident enough to expand their herds. Until there is a greater level of confidence that this disease is under control, supply growth is likely limited. Tight supplies may be alleviated to some degree by two events: hog weights and demand. Hogs are heavier with weights somewhere between 285 and 350 pounds. Prior to PED, dockage for hogs weighing much over 290 pounds was normal. This, of course, is dependent on individual slaughterhouses. In general, there is now an acceptance of heavier hogs. This will help to make up some of the short supply. Analysts seem to be split. Some are suggesting PED could affect as much as 8% to 10% of the herd. Others are suggesting it is closer to 4% or 5%. If the 4% or 5% crowd is accurate and weights are heavier, prices may struggle to move upward as total supplies could only be down 2% to 4%. The second event is that high prices will likely curb demand as well.
With the summer months trading near contract highs, producers should look for opportunities to establish a price floor in the market. This can be done through the use of puts, forward contracting, or hedges. If you choose forward contracting, consider buying out-of-the-money calls in case prices sustain a significant rally from current levels. Otherwise, the puts provide a flooring mechanism while leaving the top side open for increases from the cash market.