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RSS By: Steve Cornett, Beef Today

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Where Should Feeder Cattle Futures Settlement Prices Be?

Apr 04, 2011

Not being sure whether our friend Bill has ever hedged any cattle, and given his recent reaction to an earlier post let’s return to basis talk for his edification.

You might recall the argument is whether the weights used for calculating feeder cattle futures settlement prices should be raised. Bill, you might also recall, had recently charged that his arch-nemesis, NCBA, had suggested that action simply to help cattle feeders and packers defraud cow calf producers out of millions or even “billions” of dollars.

My response—indeed the reason behind the suggested change—is that the most important thing for everybody concerned, both long and short sides of a futures market—is accuracy. My argument is that if I’m hedging cattle that are, say, fleshy, black baldy steers weighing 761.2 lbs per head  to be delivered at 6:35 a.m. Oct. 15,  9 miles from Poteau, OK, my ideal settlement situation is for a whole contract based on cattle of that exact description.

It is unlikely, of course, that CME would ever offer such a contract. There would be too few sellers and too few buyers to make a market.

So, if I want that exact deal, then I find a buyer willing to name a price. Such a buyer is most likely to use the board one way or another to protect his investment. Even if I personally don’t understand basis or trust the futures market—the difference in the settlement prices for October feeders and the value of my specific cattle—that buyer does. He will base his bid on his best guess about how much more or less value my cattle enjoy over the average.

The key word is “guess.” Basis varies day to day, month to month, year to year. The less certainty that buyer has in basis, the more risk he is going to price into what he pays me. In other words, the less accurate the futures settlement price, the less my cattle are worth to him. We both want an accurate settlement. The actual futures price doesn’t matter. The guy will pay $1.25 for my steers, whether futures are $1.20 and he calculates a 5 cent positive basis or futures are at $1.30 if he expects a negative 5 cent basis.

But the more doubt he has about that basis, the more “insurance” he’s going to buy by pricing my cattle lower. We could have an honest argument about the proper size for feeder cattle settlement. But we can’t have an honest—key word there—argument about that basis relationship.

In the interest of arriving at some agreement on the proper definition of a “feeder,” let me offer some web search results. Here is an old, but still relevant, explanation for how basis impacts contract prices: http://pods.dasnr.okstate.edu/docushare/dsweb/Get/Document-2000/AGEC-579web.pdf

Here is a graph showing how current placement weights are running far above 10-year averages.
  

steveblogchart1


And here is a graph showing the spread between calf and feeder prices. It’s hard to read, but UGA’s Curt Lacy offers some explanation:

“Back in 2008 when feed prices reached their historical highs, the spread between 500-600 pound steers and 700-800 pound steers narrowed to $3.52 per hundredweight a much smaller difference than the normal $13.50.  Currently the spread between calves and feeder cattle is actually at a 5-year high at roughly $24 per hundredweight. “
steveblogchart2

What my buyer doesn’t need when he tries to decide how much insurance he needs on my 750-lb. baldies is for the calf/feeder spread to provide extra risk.

Bill is right about one thing. There are still some <700 lb. calves placed on feed, and that is especially true this year when drought in much of the wheat pasture country has pushed cattle off early. Bill doesn’t need to tell me about it. The La Nina scared me into sending my own steer calves to town last fall.

But cattle wean larger today than they used to. That’s a trend with no end in sight. With ethanol and cotton both pushing corn prices upward, nobody wants to place little cattle. They eat too much corn. Much better to buy them and put them on grass—the same grass opened up by all the cows that aren’t there anymore—for some cheaper gains.

The more settlement prices reflect those evolving realities, the less “guess” my buyer has to price into what he offers me on that hypothetical cash offer.

You can certainly argue about the ideal size for the feeder cattle settlement. But to argue that there is something nefarious about suggesting an increase in the weight range is pure demagoguery.

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COMMENTS (1 Comments)

Bill Bullard - Billings, MT
Hello Steve,

You are misleading your readers. Your argument in support of the proposal to eliminate cattle weighing less than 700 pounds and adding cattle that weigh 850-899 pounds to the CME Feeder Cattle Index is based on your assertion that lighter cattle, such as those weighing less than 700 pounds, no longer comprise the bulk of cattle placed in U.S. feedlots. You are wrong, dead wrong. As recently as April 1, 2011, the U.S. Department of Agriculture stated that the average feeder steer weighs 750 pounds (see USDA National Feeder and Stocker Cattle Summary – Week Ending 04-01-2011). This 750 pound steer falls right in the middle (within one pound) of the current weight range of 650-849 now used to calculate the CME Feeder Cattle Index. A review of USDA’s Cattle on Feed reports clearly show that nearly half of all cattle placed on feed in U.S. feedlots for the past several years were cattle weighing less than 700 pounds. In fact, in 2010, 46 percent of all cattle placed on feed in 1,000-head capacity feedlots in the U.S. weighed less than 700 pounds, and cattle placed on feed that weighed more than 800 pounds represented only 28 percent of all cattle placed in feedlots. Your use of Kansas data is inappropriate as it is too small a sample to address the CME Feeder Cattle Index, which is a national index that would impact all feeder cattle producers and feeders, not just those in Kansas. While it is true that more cattle weighing greater than 800 pounds are entering feedlots today as compared to in the past, the numbers of these cattle have increased by only 407 thousand head during the past six years. To put this in perspective, this six-year increase represents less than half of JBS’ one-time capacity of about 900,000 head.

Our industry has been decimated over the past several decades (in terms of our shrinking herd size and loss of 100s of thousands of producers) because producers uncritically accepted the opinions of industry leaders who producers thought were providing thoughtful, factual information. However, what we know today is that those industry leaders actually were advocating policy initiatives that benefited only a small segment of the industry at the expense of all the others. The issue of changing the CME Feeder Cattle Index is just one such example.

Bill Bullard, CEO
R-CALF USA

10:12 AM Apr 7th
 

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