Editor’s note: The following was written by Lee Schulz, Iowa State University Extension livestock economist, for the May 2019 Iowa Farm Outlook newsletter.
“Live cattle futures ended mixed, with nearby and deferred contracts lifted by spillover support from rallying hogs.” This has been a common phrase in recent market commentary.
Historically, the cattle market and hog market show a strong correlation in price trends. Not all the time, but enough to see an obvious relationship.
Understanding the normal historical levels for the price difference, or ratio, between the two markets can shed light on the current value of each price.
Linear trend lines show that live cattle and lean hog futures prices have similarly increased or decreased over three distinct periods in the last two decades. From 2000 through 2009, live cattle prices increased 30%. During that same time period, lean hog prices increased 11%.
From 2010 through 2014, cattle prices increased 52% and then decreased 28% from 2015 to currently. Similarly, hog prices increased 32% and then decreased 8% over these two periods.
The increasingly complex, uncertain and dynamic economic environment has certainly added to price volatility for all livestock markets, and during some periods, more so for some markets than others.
Even with weakened correlation between cattle and hog markets recently, is there anything we can glean from the current live cattle/lean hog price ratio that might forecast future price movements?
Since 2015, it appears that the live cattle price is too expensive once it is over double the price of lean hogs. Note the weekly nearby futures price of the cattle/hog ratio, and you only see 23 instances where the ratio ran to 2.25:1 or higher (where cattle has a premium of 125% or greater over hogs). It was only a matter of time until the trend made a major reversal and the ratio collapsed.
On the flip side, a ratio of 1.5:1 or lower (where cattle has a premium of less than 50% over the hogs) has been unsustainable.
For the week ending April 26, the cattle/hog price ratio was 1.43:1. The ratio has been this low on only 23 occasions in the last five years. Therefore, we could be expecting an eventual reversion to the mean, which has been 1.88 over the last five years, or at least resistance from a further narrowing of the spread.
Cattle and hog prices typically head in opposite directions in the summer months. In most years, cattle prices peak in March, April or May and move to a low in July, August or September. There is a normal tendency for market hog prices to show seasonal strength during late spring and summer.
This year has a slightly different look as fed cattle price inflation while lean hog price escalation has been tremendous. On March 6, the April lean hog futures contract settled at $57.075. In the span of 15 trading days, prices surged to $81.325 on March 27 before expiring at $79.300 on April 12. Corresponding April live cattle futures in March were $128.900 and $126.250.
The April live cattle futures contract expired at $123.750 on April 29. Short-term deferred contracts for both lean hogs and live cattle showed a similar pattern but at elevated levels for hogs and diminished levels for cattle.
With an eye on the August futures live cattle/lean hog ratio, the ratio has recently bottomed out below 1.2:1 (cattle has a premium of less than 20% over hogs). This is the lowest August futures contract ratio in April, or any time for that matter, in recent history.
History indicates that the August futures contract ratio usually trades in the 1.33 to 1.80 range. Where it is currently at, the ratio has a ways to go to be in that range.
On a historical basis, the cattle/hog ratio is currently telling us that live cattle futures are undervalued relative to lean hog futures. This could mean that hogs are too expensive or cattle are too cheap.
While past performance is not a guarantee of the future, analysis of the cattle/hog ratio points to an increase in the ratio and a rebalancing of live cattle and lean hog prices. If this will be a multi-week, month or even year process is unknown, and it could be that cattle prices increase or hog prices decrease.
Regardless, live cattle futures prices are attractive through August, suggesting above breakeven feedlot margins, and lean hog prices could be one factor among a bevy of factors affecting the fed cattle market that could add support to both near-term and deferred marketing periods.