By Augusto Semmelroth | Source: MLA, NLRS, Steiner
A quick assessment of key drivers of cattle prices shows that the Eastern Young Cattle Indicator (EYCI) is quoted well below its fair value. As expected, the poor season is the fundamental driver of low prices at the moment. What is the potential price recovery based on the return to average rainfall conditions?
Despite the current robust demand fundamentals, the ‘weather’ factor has dictated the performance of cattle markets since the start of 2012. The EYCI has clearly deviated from the two main export price quotes, especially after August last year (figure 1). In fact, both the 90CL frozen cow and the chilled grassfed fullset quotes have shown a steady recovery since August 2012 and are now in their 99th and 92nd percentile, respectively.
According to our EYCI price model, which takes into account beef export prices and feed grain prices, the indicator should be valued at around 386¢/kg cwt (figure 2). By not taking into account rainfall, it isolates the impact of seasonal conditions on prices. In addition, the model suggests that 84% (R2) of the movement in the EYCI is derived from the aforementioned inputs.
In years of favourable seasonal conditions, the EYCI tends to move above the model as cattle markets become largely influenced by restocker demand and limited supply. That was exactly what happened in late 2010 and 2011(figure 3). In years of poor rainfall conditions, the EYCI falls below the model as a result of increasing supplies and subdued restocker activity like in 2002, 2006 and this year (figure 3).
Right now, the EYCI is quoted at a record discount to the model. The average EYCI price for November so far is only 298.5¢/kg, while the model is pegged at 386¢/kg cwt. That’s an 87¢, or 29%, discount to its estimated fair value.
Using the drought years of 2002 and 2006 as benchmarks we can get an idea of the potential upside cattle markets could have if seasonal conditions return to average in summer. In 2002, the indicator moved from an 83¢ discount in December to a 35¢ premium in June 2003 (figure 3). A similar recovery occurred in 2006/07, when the EYCI shifted from a 50¢ discount in December 2006 to a 48¢ premium to the model in July 2007 (figure 3).
As discussed in the article ‘Direction vs Volatility – what will happen in the future?’, changes in market direction creates the risk and opportunities in the market place. That concept is now very relevant as cattle markets could be finally reaching a turning point.
As in 2002/03 and 2006/07, the only missing part of the ‘pricing puzzle’ was rainfall, and when it finally arrived it triggered a strong and fast market recovery. In both years, prices returned to a fair value and subsequently to a premium to the model in only a few months.
While the weather risk is still present, a similar improvement in rainfall conditions (like in 2003 and 2007) should see a substantial rally in cattle prices in the short-term. That would see the EYCI quickly returning to its fair value to reach 360-80¢/kg cwt in the first months of 2014.
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