Keep an Eye on Corn, Fed Cattle Prices for Feeder Cattle Direction
If you think the corn market has been a wild ride lately, look at what's going on in the cattle market, specifically for feeder cattle.
Daily trading limits for feeder cattle have been bumped higher after previous limits were touched on both the low and high sides in the last few weeks. After 10 days of limit-up trading last month, January started with a limit-down day for the nearby futures contract for feeders. To put that into perspective, live cattle futures -- a vibrant market right now on its own -- have touched the daily trading limit just twice, both on the high side, in the last year. Hog futures haven't seen that happen in the last two months.
So, what's behind this volatility? Just look at the two ends of the production chain, corn futures on one side and fed cattle on the other. Both have seen major swings in the last few weeks, making them like a couple of ping pong paddles hitting the ball -- feeder cattle futures -- back and forth, high and low.
"It helps to think about feeder cattle prices as the 'shock absorber' between fed cattle prices on one end, and corn prices on the other," says University of Illinois Extension ag economist Paul Peterson. "When buying feeder cattle, feedlots look at the gross feeding margin, which is the difference between the amount received when fed cattle are marketed and the amounts paid for corn and feeder cattle, the two major inputs."
Corn -- the primary feedstock for cattle feeders -- has been cheap in the last few months, but it saw some upward momentum late last year. Lower corn prices mean it's easier to make money feeding cattle. At the same time, demand is strong, driving fed cattle prices higher. So, the growing price extremes are causing market gyrations for feeder cattle that make it easy to see why a limit-up or limit-down trading day is a more common occurrence now than in the past.
"Cattle feeders have little direct influence over fed cattle prices and corn prices, but feeder cattle prices are different. If the gross feeding margin is positive, feedlots have room to bid up feeder cattle prices; if the margin is negative, feedlots eventually back away, which puts downward pressure on feeder cattle prices," Peterson says. "Fed cattle prices climbed to record levels in 2014 due to tight supplies of beef and strong demand from domestic and overseas consumers. However, beef prices stalled at the beginning of December."
They fell, but not as much as they did earlier in the year when fed cattle prices plunged. Why not?
"Beef prices fell nearly twice as much in August and September 2014 as in December 2014, and lower beef prices dragged down fed cattle prices, but it caused only a blip in feeder cattle prices," Peterson adds. "The answer is corn prices, which dropped 50 cents per bushel or more between early August and the mid-September harvest lows. Those lower corn prices offset the effects of lower fed cattle prices in the gross feeding margin calculation, so that feeder cattle prices remained firm. It was a much different story in mid-December. Corn prices were $1.00 per bushel higher than the harvest lows and had been putting pressure on feeder cattle prices. When beef and fed cattle prices weakened, feeder cattle prices had nowhere to go but down."
Moving forward, this type of volatility will likely continue as corn prices chop around amidst their own set of up-and-down factors. Though it may be tempting to watch just one of these markets for direction in the feeder cattle market, it will remain critical to watch both the corn and fed cattle markets moving through 2015.
"Feeder cattle futures have since recovered about one half of the mid-December losses, and the question on many minds is, 'Where do we go from here?' The events of the past month are a useful lesson to buyers and sellers of feeder cattle," Peterson says. "While it's tempting to watch just fed cattle prices or just corn prices, it's important to keep an eye on both markets -- or better yet, on gross feeding margins -- to gauge the future direction of feeder cattle prices."