November 18, 1996 Ames, Iowa Econ. Info. 1706

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1 November 18, 1996 Ames, Iowa Econ. Info LEAN HOG CARCASS BASIS The new Lean Hog futures contract differs from its predecessor in several ways. It is traded on carcass weight and price rather than live weight. It represents a leaner hog than the previous carcass. Finally, it will use a cash settlement instead of live delivery to close the contract. These changes have implications for the basis used by producers to estimate hedging returns. The cash settlement price index is a two-day weighted average of the three direct trade markets, Western Corn Belt, Eastern Corn Belt, and Mid South. Iowa, Minnesota, Nebraska, Missouri, and South Dakota are in the Western Corn Belt. Daily Prices... Table 1 summarizes nearly a year of daily price data in the Western Corn Belt (WCB) and the Chicago Mercantile Exchange (CME) cash settlement index. The table includes the average, minimum, maximum, and the standard deviation. The standard deviation is a measure of variability. Observations are within a range from one standard deviation below the average to one standard deviation above the average 68 percent of the time. Prices will be above this range approximately 16 percent of the time and below this range also about 16 percent of the time. The variation in these prices is relatively high because of the upward trending prices over this time period. Table 1. Western Corn Belt Carcass Prices and CME Three Market Index, November, October, 1996: 51-52% Lean. Cash Cash Hi-Low CME Low High Spread Index ($/cwt) ($/cwt) ($/cwt) ($/cwt) Average Std Dev Minimum Maximum Note that the daily price spread in the WCB between the high and the low averaged $7.05/cwt. Sixty-eight percent of the time this spread was between $6.04 and $8.06. Carcass Basis... Table 2 summarizes two measures of the WCB basis using the average of the high and low WCB price. The first column is the simple difference between the average WCB and the CME Index (WCB- CME). The second column expresses the WCB price as a percentage of the CME Index (100 x WCB/CME). The average basis was a positive $.33/cwt (WCB larger than CME) and the range was from -$2.62 to $2.14. Approximately 16 percent of the time was more negative than -$.40/cwt. This is the average basis minus one standard deviation ($.33 -$.73 = -

2 $.40). Figure 1 (not available) shows the basis over the last year. The basis appears to have improved since March. However, the data series is too short to feel confident that the relationship has changed. Percentage-wise, WCB and the CME index were nearly identical and the standard deviation was one percent. Figure 2 (not available) is a graph of the percentage basis. Table 2. Western Corn Belt 51-52% Lean Carcass Basis to the CME Index, $/cwt and Percentage. WCB-CME WCB/CME $/cwt Percent Average Std Dev Minimum Maximum Table 3 shows the price difference between the WCB percent lean and the and percent lean carcasses. These numbers summarize the daily average differences for November October Carcasses that are percent lean averaged $2.99/cwt less than the percent lean price. The percent lean carcasses averaged $2.03 lower. Producers estimating their basis for making hedging decisions must understand how their hogs and their packer bids compare to the futures. When producers receive a packer bid that has a base of 49 percent lean, it may well be $2.00 below the futures price at expiration, based on Table 3. However, if the producers' hogs are 51 percent lean, the producer will receive a lean premium from the packer. The process is not as complicated as it sounds if the producer knows the packer lean base and how his hogs perform on the packer's carcass merit buying system. This analysis suggests that producers hedging hogs with the CME Lean Hog futures may have a relatively small basis for percent lean hogs. They will still need to monitor how the bid they receive from their packer tracks the WCB price. Table 3. Difference Between and Percent Lean Prices and the Percent Lean Price, Western Corn Belt. Price Difference From 51-52% 47-48% 49-50% Average Std Dev Minimum Maximum Mid-Am Contract... The Mid-Am Exchange has also changed its contract. This contract still uses live weight and price. The contract size is smaller than the CME contractþ25,000 pounds live weight or approximately 100 hogs. Cash settlement will be used based on the Iowa-Southern Minnesota US Grade 1, 2, and 3, pound

3 barrow and gilts, plant delivered. Producers with fewer hogs to sell at one time may prefer this contract. However, the Mid-Am has traditionally had less volume and liquidity which means that it may be more difficult to get into and out of a position. It may cost a little on each trade because there may not be a ready buyer (seller) at your price and you have to accept less (more) than expected, i.e., $.10 - $.20/cwt. This liquidity problem may be less of an issue if the new hog contract becomes popular with producers. The liquidity penalty may be less than the basis risk associated with matching the larger CME contract size....john Lawrence CORN, SOYBEAN CROP ESTIMATES TEMPER PRICE PROSPECTS USDA's November 12 crop report showed larger-than-expected increases in corn, soybean, and grain sorghum production estimates. While the indicated crops are well below record highs, feed grain supplies represent a moderate easing from last year's critically tight global supplies. In contrast to feed grains, world oilseed supplies are down about 1 percent from a year ago. The U.S. corn production estimate was raised 3 percent from last month, along with a 2 percent increase in soybean production. The larger corn production estimate and cumulative exports that are 45% less than last year will likely limit potential strength in corn cash and futures prices between now and early spring. Even so, modest strength (perhaps 8-15 /bushel) in Iowa cash prices is possible between now and early February. Limited world competition and strong export demand appear likely to bring moderately higher cash soybean prices between now and mid- February. There are caution signs for late February and early March for both corn and soybeans. Farmers are storing their crops heavily, but will likely increase marketings in late winter to meet major cash flow needs. That may temporarily weaken both corn and soybean prices. Some analysts believe there is risk that March corn futures at that time could attempt to retest fall lows. Marketings may increase a little the first several days of January as farmers enter the new tax year, but major increases in farmer sales appear likely to occur several weeks later. Feed Grain Production... U.S. corn production is now indicated to be 26% above last year's weather-reduced crop. Yields were above last year in most of the Midwest except for Wisconsin, Michigan and Ohio. Almost all major producing states showed higher yields than indicated a month ago. Yield increases from the October report and from 1995 are shown below: Bu/A Chg. vs Bu/A Chg. vs Oct. Est Oct. Est. 1995

4 Iowa Illinois Nebraska Indiana S. Dakota Wisconsin +2-5 Minnesota Michigan 0-21 Missouri Ohio +6-7 Colorado Texas N. Carolina 0-19 US USDA's National Agricultural Statistics Service (NASS) will issue one more 1996 crop report for this marketing year, in mid- January. Patterns from the last 20 years indicate an increase is likely in January in years when crop estimates increased each month from September through November, as they did this year. It would not be surprising to see a January corn production estimate of 9.35 to 9.4 billion bushels. That would still be well below the 1994 record of 10.1 billion bushels. Large Increase in Grain Sorghum Crop... An increase in the grain sorghum production estimate also seems likely in January. U.S. grain sorghum production is now estimated at 820 million bushels, 78% or 360 million bushels above The sharp increase is due to extensive replanting of failed wheat to sorghum, and favorable weather from May onward. The larger crop means 300 to 320 million bushels more grain sorghum will be available for feeding and exports this season than in Most of the increase is expected to be fed. Feedlots from Kansas southward will use grain sorghum extensively in rations this winter as a replacement for corn. By spring, demand for corn in the central and southern plains should be somewhat stronger, although wheat pastures may also help to extend feed supplies. Wheat pasturing was almost non-existent in the marketing year. World Crop Estimates... USDA's world crop estimates place world wheat production at 8 percent above last year, along with an 11 percent increase in world feed grain production. The increases follow a 9% drop in world feed grain production last year, the second largest percentage decline on record. Total world feed grain supply, however, is indicated to be up a more modest 5% due to sharply lower old-crop carryover stocks. World oilseed production is indicated to be up 0.7% from , assuming weather is favorable in South America this winter and early spring. Total world supplies of major oilseeds are estimated to be down about 1% because of lower carryover stocks. South American Soybeans... The projection of Argentina's spring 1997 soybean harvest was lowered 18 million bushels from last month, partially offsetting the larger U.S. crop. Brazil's soybean crop projection remained unchanged from last month and up 12 percent from last year. At this early stage of the planting season, parts of Brazil have been wet, slightly delaying plantings. Soybean Exports Recover... Weekly U.S. soybean exports have moved above last year's high levels. Bean and bean product exports should remain strong through at least April, due to limited old-crop South American

5 supplies and limited oilseed production in Canada, Western Europe, and China. Exports of U.S. soybeans to date plus outstanding unshipped sales are 24% above a year ago. Soybean meal shipments and outstanding unshipped sales are up 87%. The comparable total for soybean oil is up 70% from mid-november of last year. Domestic crushings (processing) of soybeans has been slightly above a year ago in recent weeks. Strong demand for soybeans and relatively tight world oilseed supplies may push cash soybean prices 25 to 35 cents above mid- November levels between now and early February. Additional price strength would be quite likely with any widespread South American weather problems. The November world crop estimate indicates combined exports of South American soybeans and soybean products will be slightly larger than those of the U.S. this marketing year, provided its growing season is favorable. The peak soybean planting season in South America extends from the last half of November through mid-december. Some double-cropped beans are planted into early February....Robert Wisner