MONTHLY MARKET PROFILE: 12/10/04 Nevil C. Speer, PhD, Western Kentucky University

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1 MONTHLY MARKET PROFILE: 12/10/04 Nevil C. Speer, PhD, Western Kentucky University The market seems like a heavyweight match with packers and feeders standing toe-to-toe slugging it out. Negotiations are critical. Each side is attempting to curtail losses (more on that later) while establishing leverage prior to the Christmas holiday with hopes of follow-through as the New Year begins. That scenario, coupled with a variety of external factors including weather and BSE screening, has created some substantial market swings during the past several weeks and relatively erratic trade. Mid-November s fed trade began on a positive note but was immediately stalled by notification of an inconclusive BSE test result. Subsequent to negative confirmation fed trade moved sharply higher as packers found themselves somewhat short bought and needing cattle; negotiations ended largely in feedyard favor at $ Thanksgiving brought about trade which settled uncharacteristically early the following week; feedyards again won that round with another $1-2 being tacked on to the previous week s gains. December s first full week, though, was more business-as-usual : settlement didn t occur until late in the week. Feedyards hung on to hopes that procurement needs would be sizeable in preparation of the holidays, the previous week s action meant showlist availability was slim, and sloppy pen conditions wound all underpin final prices. However, packers had trouble moving inventory without some discount; the light-choice cutout slid nearly $6 in three days and finished the week just slightly better than $142 (compared to nearly $148 on Tuesday s close). Meanwhile, action at the CME also pressured live sales; the December contract ended the week at $85.50 off sharply from its near-term high just 10 days prior ($90.33 on November 30). The culmination eroded feedyard staying power. Trade ended the week largely $5-6 lower. Traders at the Merc have been busy sorting through a variety of factors that potentially influence the market including long-term implications had the BSE inconclusive been positive, winter weather, news reports about Canadian trade and the cattle-on-feed report. Response to those factors has been mixed but, as mentioned previously, has been largely bearish. Interpretation of USDA s cattle-on-feed report was two-sided. Favorable short-term implications were derived from the read on October marketings. The reported number was 3% below 2003 s value. However, there were two less marketing days in October, 2004 compared to 2003; as such, this year s marketing rate was actually improved. In fact, October marked the first time in 2004 in which a given week possessed positive harvest activity relative to weeks ending Oct 15 and 29, respectively (the week ending Dec 10 also saw FI slaughter ahead of last year s pace the first since those just mentioned). On the flip side, though, the report s longer term implications were seemingly unfavorable: October s placements continue a biased trend towards heavier cattle. As outlined last month, those cattle will possess little marketing flexibility and could confound carryover if it becomes burdensome in coming months. Warning signs about Currentness lie primarily in recent slaughter weight trends. Following mid-october s peak of 838 lb steer carcass weights moderated for several weeks, down to 826 lb in early November, but then began to climb again likely a reflection of increased days on feed. Most recently steer carcass weights for the week of November 20 were 832 lb and then plunged 10 lb for the final week in November. Much of the week s 10 lb decline, though, is an artifact of winter weather not improved currentness. Last week s wholesale dive coupled with an apparent buildup on the front-end of the cattle supply could keep the market under pressure as we transition into Given tight margins on both sides don t be surprised by continuation of tough negotiations. From a broad perspective 2004 s market activity, in review, will likely be depicted by the influence of BSE-induced trade embargoes and implementation of new feed regulations. Closer analysis, though, reveals some interesting developments which potentially possess some

2 Nevil C. Speer, Ph.D. Page 2 12/10/04 important business implications for the beef industry. Detailing the foundation of that occurrence has been MMP s primary focus over the previous two months. October s discussion surrounded feeder cattle market behavior. Critical to that analysis is the market s seeming disregard for historical seasonal patterns during both 2003 and 2004; seasonal deviations amplified with each passing week making closeout prospects appear very tenuous. Fed trade, though, has consistently shifted upwards to bail out feedyards and allowed them to salvage profitability from those purchases. However, current choppiness in the fed market and apparent resumption of seasonality has begun to pressure closeouts. November s MMP highlighted seasonal behavior of light-choice cutout values and weekly beef production. From a packer perspective, summer 2004 presented limited opportunity to increase throughput. Simultaneously cutout values declined sharply after mid-june; the culmination of several negative factors in a short period of time. The net result has been negative production margins since the middle of June. The upshot of these discussions is that both packers and feeders are now in a difficult position. Despite enthusiasm about the absolute values of the market it s important to remember that cattle feeders and packers are margin operators; both entities are currently being squeezed. On one hand, feedyard revenue has been limited since June by fed market choppiness while also dealing with high costs sourcing from an unprecedented feeder cattle market. On the other hand, packer revenue has been pressured by the inability to achieve upside follow-through with respect to wholesale values while also purchasing cattle within a historically high fed market. A disclaimer before moving on with further discussion: true packer margins are extremely difficult to assess one can only do that only through access to specific inventory movement coupled with costs of production and purchases versus sales revenue. All of the items previously mentioned are proprietary information. However, the industry circumvents that shortcoming by utilizing industry-wide assumptions; per those estimates (including my own) margins have been largely negative for the packing industry since the middle of June. Simultaneously, feedyard closeout profitability is also difficult to estimate for many of the same reasons listed above. There are a number of items which vary widely across the sector including measures such as purchase cost, grid marketing agreements, cost-of-gain and cattle performance. Once again, fundamental assumptions suggest some insight into overall tendencies. That being said, the most import focus is not on the actual values but rather the relative trends. The illustrations below represent gross profit (revenue less cost-of-goods sold) for packers and feeders over the past two years. The data is derived from several sources: packer gross profit equals LMIC s price spread less $125/head processing cost; feedlot gross profit equals fed steer value less yearling steer cost purchased 150 days prior less LMIC s cost-of-gain estimates. Profitability was largely available for both packers and feeders during 2003; it was an unprecedented period in which we saw positive margins for all sectors of the beef complex. Moreover, cattle feeders prior to this point have experienced a period of historic profits; Cattle- Fax estimates that during the past 21 months the cattle feeding industry has made more money than in the previous 288 months combined. However, since the middle of the summer that trend has reversed as margins have begun to decline rapidly. Packer margins are following much the same pattern; as an example, Tyson s 4 th -quarter (ending October 2) operating income margin (1.3%) was off sharply from the previous quarter (4%) and well below last year s figure. Those factors will play on the market over the next several months. Despite some buildup of cash reserves and/or equity positions over the past 18-to-24 months, current negative cash flow on both sides of negotiations simply isn t sustainable week after week. The result will be some tough bargaining in weeks to come. Given that reality, coupled with ongoing developments relative to international trade, it s not unlikely we ll see choppy, variable trade with both fed trade and wholesale movement occurring in surges. Bottom line: large market swings can t be ruled out; the market s volatility we ve witnessed over the previous 24 months may continue in the months to come. More on that next month.

3 Nevil C. Speer, Ph.D. Page 3 12/10/04 Gross Profit: 2003 (Adapted from Cattle-Fax and LMIC) 375 Feedyards Packers Gross Profit ($/head) JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Gross Profit: 2004 (Adapted from Cattle-Fax and LMIC) 175 Feedyards Packers Gross Profit ($/head) JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV

4 Nevil C. Speer, Ph.D. Page 4 12/10/04 USDA Cattle-on-Feed Report: NOVEMBER 19, 2004 U.S. 7-State Total versus Total versus Date Category (000 head) Last year 5-yr avg (000 head) Last year 5-yr avg 1-November-04 Cattle on Feed 11,334 +3% -1% 9,856 +3% Even October Marketings 1,798-3% -5% 1,553-1% -5% October Placements 2,701-3% -2% 2,323-2% -1% USDA Cattle-on-Feed Report: NOVEMBER 19, 2004 Monthly Placements (000 head) and Percent of Year-Ago (%) Placement Weight Categories (lb) Month < Total May % % % 610 % 2, % Jun % % % % 1,644 98% Jul % % % % 1,720 86% Aug % 413 % % % 2,099 88% Sep % % % % 2,385 96% Oct % % % % 2,701 97% Total 3,441 98% 2,823 94% 3,375 94% 3,277 94% 12,916 95% USDA Cold Storage Report: NOVEMBER 19, October September-04 Total Versus Total Versus Category (000 lb) 2003 September (000 lb) 2003 August Beef 459, % Even 457, % +3% Pork 445,212 Even +5% 422,116-3% +8% Poultry 1,291,446 +9% -1% 1,306,180 +4% -1% Total 2,195,681 +9% Even 2,185,540 +6% +2%

5 Nevil C. Speer, Ph.D. Page 5 12/10/04 PRICE SUMMARY WEEK ENDING: ITEM 10-Dec 3-Dec 26-Nov 19-Nov 12-Nov Slaughter Steers ($/cwt) nt Light Choice Cutout: LB ($/cwt) Light Select Cutout: LB ($/cwt) Hide and Offall ($/cwt) USDA Slaughter Weights (lb) USDA Steer Carcass Weights (lb) Cattle-Fax Days on Feed Steer Calf: 450 LB ($/cwt) Steer Calf: 550 LB ($/cwt) Yearling Steer: 650 LB ($/cwt) Yearling Steer: 750 LB ($/cwt) CME Feeder Cattle Index ($/cwt) n/a Yearling:Fed Steer Ratio (%) Slaughter Cows: Utility/Commercial ($/cwt) Slaughter Cows: Canner/Cutter ($/cwt) Cow Cutout ($/cwt) Corn (basis Omaha: $/BU) Cattle Harvest (000 head) Beef Production (million lb)