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Tuesday, November 22, 2016

Undervalued to overvalued in two seasons

By Matt Dalgleish  |  Source: USDA, MLA, ACA

Key points

  • A strong long term correlation exists between yearly average US Live Cattle and QLD Medium Steer prices
  • This correlation allows us to measure the percentage variation that local prices are from the normal long term relationship, thus creating a measure of how over or under valued the domestic market is trading.

2016-11-22 Cattle Market Fig 1

2016-11-22 Cattle Market Fig 2

2016-11-22 Cattle Market Fig 3

There is an undeniable link between US cattle markets prices and local prices, particularly when looking at average yearly prices over the long term. This analysis investigates the relationship between Queensland Medium Steers and US Live Cattle Futures, with a focus on how undervalued or overvalued local prices have been according to the long-term price relationship.

Taking a look at long term average yearly values between US and Australian cattle we can see that a reasonably strong relationship exists between these two markets, with QLD medium steer prices mirroring the movement in US Live Cattle futures – figure 1. This is unsurprising given the importance of the US to the Australian market, as they are one of our largest export buyers and also a major competitor into our primary beef export destinations.

Figure 2 expresses the relationship between the two series, since 1953, and shows the correlation between the yearly average price of US Live Cattle and QLD Medium Steers expressed in US¢/kg, along with a line of best fit (dotted line). The line of best fit could be viewed as a measure of “long term fair value” since it represents how the price of QLD Medium Steers relates to US Live Cattle and the high correlation coefficient (R-squared) of 0.9038 indicates a very strong correlation between the annual yearly prices of the two series.

The impact of the drought during the 2013-14 season, and the associated high turnoff rate during that time, is evident in how undervalued local cattle prices remained when compared to US prices. Indeed, looking at the distance the data point for each year is from the line of best fit can give an indication of how undervalued or overvalued the price of QLD Medium Steers are to US prices. However, to get a more robust picture of long term value it is probably prudent to measure the percentage variance from the yearly data point to the line of best fit as this will show how extreme the variance is each year relative to the prevailing nominal prices.

An example of this would be to compare the mid-70s drought to the recent drought, figure 2 shows the data point for 1975 with US Live Cattle at 71US¢/kg and QLD Medium Steers at 24.3US¢/kg. If not for the drought the long term fair value relationship (line of best fit) would have suggested QLD Medium Steers should have been at 40.1US¢/kg or, in percentage variance terms, was 39.5% undervalued. Contrast this to the 2014 data point and we can see that with US Live Cattle at 331.3US¢, QLD Medium Steer at 152.9US¢ and the fair value line showing that QLD Medium Steers should have been at 209.6US¢/kg, thus representing a percentage variance of 27.1% undervalued. Using the measure of percentage variance from the long term fair value line we can see that local prices during the 1975 drought were more undervalued than in 2014.

What does this mean?

Figure 3 shows the percentage variance from the fair value line for QLD Medium Steers since 1953, overlaid with the longer-term average (black dotted line), the 70% range (green shaded zone) and the 95% range (red dotted lines).

This chart can give a quick visual measure of how undervalued or overvalued QLD Medium Steers are compared to US prices and highlights how the mid-70s drought had a more extreme and longer impact on local cattle prices than the 2013-14 period drought. It also shows that the under the current high priced “grass fever” environment local cattle prices are testing toward extremely overvalued territory when compared to the US cattle market.

Mecardo information is provided to assist in your marketing decisions. It contains a range of data and views on the current market. It is not intended to constitute advice for a specific purpose. Before taking any action in relation to information contained within this report, you should seek advice from a qualified professional. The information is obtained from a variety of sources and neither Mecardo nor Ag Concepts Advisory will be held liable for any loss or damage whatsoever that may arise from the use of information or for any error or mis-statement contained in this report. 

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