By Justin Gleghorn, risk management consultant
The feeder cattle index remains in a bear trend, despite a minor rally beginning in the end of October and running through the first week in November. This is not surprising as seasonally the feeder cattle index trades lower through the end of the year and does not begin to rally until spring. Previously we have commented on the potential for a counter-seasonal price action, whereby the index looked as though it could trade higher through the fall. However, this does not appear to be the case; and multiple factors may explain this.
The corn market has traded harvest and crop quality news for the last two months. Fears of delayed harvest and problems associated with inadequate drying of the grain have fueled the bull traders. In addition to these fears, the continued weakness of the US dollar index has prompted bullish activity in commodities such as crude oil and grains. Perhaps the most negative influence in the feeder cattle index is the activity of the live cattle market. Live cattle traded higher from the beginning of October through the end of the month, but by the second week of November cash price had declined approximately $3.00/cwt. While this change in cash price occurred in the live cattle market, the feeder cattle index declined $4.00/cwt.
At this point we look for continued bearish activity in the feeder cattle index. Until the live cattle market shows some life we cannot expect feeder cattle to break their current bear trend. If price is not protected at this point, it may be beneficial for a producer to buy puts for downside protection and risk is limited to the price paid for the put. With this strategy, the producer may be able to take advantage of a rally; as long as the rally exceeds the price paid for the put. If a short hedge strategy is implemented the producer may limit their upside potential as the gains made in the cash market would be offset by their loss in the futures market.
Too much volatility exists in the current marketplace and the lack of downside price protection may prove to be detrimental to the producer. Some form of price protection is necessary as the feeder cattle index is influenced by markets beyond the cattle industry. Although we may be short of cattle numbers and a strong rally could be expected, this does not change the fact that our market is influenced by outside factors and the expected rally may be further away than we anticipate.
--Justin Gleghorn is Risk Management Consultant with Brock Thompson Trading in Amarillo, Texas. You can reach him via e-mail at firstname.lastname@example.org
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